data. The word ‗Accounting‘ can be classified into three categories: (A) FinancialAccounting (B) Management Accounting and (C) Cost Accounting.

Branches of Accounting

Financial Management Cost

Accounting Accounting Accounting

FINANCIAL ACCOUNTING:Financial Accounting has come into existence with the development of large-scalebusiness in the form of joint-stock companies. As public money is involved in sharecapital, Companies Act has provided a legal framework to present the operating resultsand financial position of the company. Financial Accounting is concerned with thepreparation of Profit and Loss Account and Balance Sheet to disclose information to theshareholders. Financial accounting is oriented towards the preparation of financialstatements, which summarises the results of operations for select periods of time andshow the financial position of the business on a particular date. Financial Accounting isconcerned with providing information to the external users. Preparation of financialstatements is a statutory obligation. Financial Accounting is required to be prepared inaccordance with Generally Accepted Accounting Principles and Practices. In fact, thecorporate laws that govern the enterprises not only make it mandatory to prepare suchaccounts, but also lay down the format and information to be provided in such accounts.In sharp contrast, management accounting is entirely optional and there is no standardformat for preparation of the reports. Financial Accounts relate to the business as awhole, while management accounts focuses on parts or segments of the business .

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT 1

CONCEPT OF MANAGEMENT ACCOUNTING:Management Accounting is a new approach to accounting. The term ManagementAccounting is composed of two words — Management and Accounting. It refers toAccounting for the Management. Management Accounting is a modern tool tomanagement. Management Accounting provides the techniques for interpretation ofaccounting data. Here, accounting should serve the needs of management. Managementis concerned with decision-making. So, the role of management accounting is to facilitatethe process of decision-making by the management. Managers in all types oforganizations need information about business activities to plan, accurately, for thefuture and make decisions for achieving the goals of the enterprise. Uncertainty is thecharacteristic of the decision-making process. Uncertainty cannot be eliminated,altogether, but can be reduced. The function of Management Accounting is to reduce theuncertainty and help the management in the decision making process. Managementaccounting is that field of accounting, which deals with providing information includingfinancial accounting information to managers for their use in planning, decision-making,performance evaluation, control, management of costs and cost determination forfinancial reporting. Managerial accounting contains reports prepared to fulfil the needs ofmanagements.

1.2 MANAGEMENT ACCOUNTING-DEFINITION

Different authorities have provided different definitions for the term ‗ManagementAccounting‘. Some of them are as under:

―Management Accounting is concerned with accounting information, which is useful to the

management‖. —Robert N. Anthony

―Management Accounting is concerned with the efficient management of a business

through the presentation to management of such information that will facilitate efficientplanning and control‖. —Brown and Howard

―Any form of Accounting which enables a business to be conducted more efficiently canbe regarded as Management Accounting‖ —The Institute of Chartered Accountants of Englandand Wales

The Certified Institute of Management Accountants (CIMA) of UK defines the term

‗Management Accounting‘ in the following manner:

―Management Accounting is an integral part of management concerned with identifying, presenting

and interpreting information for:

1. Formulating strategy2. Planning and controlling activities3. Decision taking4. Optimizing the use of resources5. disclosure to shareholders and others, external to the entity6. disclosure to employees7. safeguarding assets

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 2From the above definitions, it is clear that the management accounting is concerned withthat accounting information, which is useful to the management. The accountinginformation is rearranged in such a manner and provided to the top management foreffective control to achieve the goals of business. Thus, management accounting isconcerned with data collection from internal and external sources, analyzing, processing,interpreting and communicating information for use, within the organization, so thatmanagement can more effectively plan, make decisions and control operations. Theinformation to be collected and analysed has been extended to its competitors in theindustry. This provides more meaningful clues for proper decision-making in the rightdirection.

The information in the management accounting system is used for three differentpurposes:1. Measurement2. Control and3. Decision-making

1.3 SIGNIFICANCE OF MANAGEMENT ACCOUNTING

The various advantages that accrue out of management accounting are enumeratedbelow:(1) Delegation of Authority: Now a day the function of management is no longer personal, management accounting helps the organisation in proper delegation of authority for the attainment of the vision and mission of the business.(2) Need of the Management: Management Accounting plays the role in meeting the need of the management.(3) Qualitative Information: Management Accounting accumulates the qualitative information so that management would concentrate on the actual issue to deliberate and attain the specific conclusion even for the complex problem.(4) Objective of the Business: Management Accounting provides measure and reports to the management thereby facilitating in attainment of the objective of the business.

1.4 ROLE OF MANAGEMENT ACCOUNTING IN MANAGEMENT PROCESS

An enterprise would operate, successfully, if it directs all its resources and efforts toaccomplish its specified objective in a planner manner, rather than reacting to events.

Organisation has to be both efficient and effective. Organisation is effective when theplanned objective is achieved. However, the firm is efficient only when the objective isachieved, with minimum cost and resources, both in physical and monetary terms. Therole of Management Accounting is significant in making the firm both efficient andeffective. Management Accounting has brought out clear shift in the objective ofaccounting. From mere recording of transactions, the emphasis is on analyzing andinterpreting to help the management to secure better results. In this way, ManagementAccounting eliminates intuition, which is not at all dependable, from the field of businessmanagement to the cause and effect approach.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

Planning Organising Controlling Decision-making Staffing

Management accounting plays a vital role in the managerial functions performed by themanagers.

1. Planning: Planning is the real beginning of any activity. Planning establishes the objectives of the firm and decides the course of action to achieve it. It is concerned with formulating short-term and long-term plans to achieve a particular end. Planning is a statement of what should be done, how it should be done and when it should be done. While planning, management accountant uses various techniques such as budgeting, standard costing, marginal costing etc for fixing targets. For example, if a firm determines to achieve a particular level of profit, it has to plan how to reach the target. What products are to be sold and at what prices? The Management Accountant develops the data that helps managers to identify more profitable products. What are the different ways to improve the existing profits by 25%? Management Accounting throws various alternatives to achieve the goal.2. Organising: Organising is a process of establishing the organizational framework and assigning responsibility to people working in the organization for achieving business goals and objectives. The organizational structure may not be the same in all organizations, some may have centralized, while others may be decentralized structures. The management accountant may prepare reports on product lines, based on which managers can decide whether to add or eliminate a product line in the current product mix.3. Controlling: Control is the process of monitoring, measuring, evaluating and correcting actual results to ensure that a firm‘s goals and plans are achieved. Control is achieved through the process of feedback. Feedback allows the managers to allow the operations continue as they are or take corrective action, by some rearranging or correcting at midstream. The use of performance and control reports serve the function of controlling. For example, a production supervisor may receive weekly or daily performance reports, comparing actual material cost with planed costs. Significant variances can be isolated for corrective action. In the normal course, periodical reports are submitted, appraising the performance against the targets set. Reports for action are given to the top management, following the principle of management by exception. Performance and control reports do not tell managers what to do. These feedback reports identify, where attention is needed to help managers to determine the required course of action.4. Decision-making: Decision-making is a process of choosing among competing alternatives. Decision-making is inherent in all the above three functions of management-

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 4 planning, organizing and controlling. There may be different methods or objectives. The manager can plan or choose only one of the competing plans. Similarly, in organizing, decision can be made whether the organizational structure should be centralized or decentralized. In control function, manager can decide whether variance is worthy to investigate or not.5. Staffing: Staffing is the process of recruitment, selection, development, training, compensation and overseeing employee in an organisation. Staffing, like all other managerial functions, is the duty which is vest on the management to perform. The role of the management accounting in this regard is manning the entity structure through proper and effective selection, appraisal, and development of the personnel to fill the role assigned to the employer. Moreover, the management accountants have to reduce the labour turnover and to control the overall employee cost.

1.5 FUNCTIONS OF MANAGEMENT ACCOUNTING

The primary objective of Management Accounting is to maximize profits or minimize

losses. This is done through the presentation of statements in such a way that themanagement is able to take corrective policy or decision. The manner in which theManagement Accountant satisfies the various needs of management is described asfollows:

Forecasting and Decision-making. Management accounting collects the data from various sources and stores the information for appropriate use, as and when needed. Though the main source of data is financial statements, Management Accounting is not restricted to the use of monetary data only. While preparing a sales budget, the management accountant uses the past data of the products sold from the financial records and makes projections based on the consumer surveys, population figures and other reliable information to estimate the sales budget. So, management accounting uses qualitative information, unlike financial accounting, for preparing its reports, collecting and modifying the data for the specific purpose.2. Modification and Presentation of Data: Data collected from financial statements and other sources is not readily understandable to the management. The data is modified and presented to the management in such a way that it is useful to the management. If sales data is required, it can be classified according to product, geographical area, season-wise, type of customers and time taken by them for making payments. Similarly, if production figures are needed, these can be classified according to product, quality, and time taken for manufacturing process. Management Accountant modifies the data according to the requirements of the management for each specific issue to be resolved.3. Communication and Coordination: Targets are communicated to the different departments for their achievement. Coordination among the different departments is essential for the success of the organisation. The targets and performances of different departments are communicated to the concerned departments to increase the efficiency of the various sections, thereby increasing the profitability of the firm. Variance analysis is an important tool to bring the necessary matters to the attention of the concerned to exercise control and achieve the desired results.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 54. Financial Analysis and Interpretation: Management accounting helps in strategic decision making. Top managerial executives may lack technical knowledge. For example, there are various alternatives to produce. There is always a choice for the sales mix. Management 344 Accounting for Managers Accountant gives facts and figures about various policies and evaluates them in monetary terms. He interprets the data and gives his opinion about various alternative courses of action so that it becomes easier to the management to take a decision5. Control: It is absolutely essential that there should be a system of monitoring the performance of all divisions and departments so that deviations from the desired path are brought to light, without delay and are corrected then and there. This process is termed as control. The aim of this function ‗control‘ is to facilitate accomplishment of the goals in an efficient manner. For the discharge of this important function, management accounting provides meaningful information in a systematic and effective manner. However, the role of accountant is misunderstood. Many consider the accountant as a controller of their performance. Many accountants themselves misunderstand their own role as controllers. The real role of control is effective communication and assists the managers in achieving their goals, as efficiently as possible.6. Supplying Information to Various Levels of Management: Every level of management requires information for decision-making and policy execution. Top-level management takes broad policy decisions, leaving day-to-day decisions to lower management for execution. Supply of right information, at proper time, increases efficiency at all levels.7. Reporting to Management: Reporting is an important function of management accounting to achieve the targets. The reports are presented in the form of graphs, diagrams and other statistical techniques so as to make them easily understandable. These reports may be monthly, quarterly, and half-yearly. These reports are helpful in giving constant review of the working of the business.

Storehouse of Reliable Data

Modification and Presentation of Data

Communication and Coordination

Financial Analysis and Interpretation

Control

Supplying Information to Various Levels of Management

Reporting to Management

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT 6

1.6 LIMITATIONS OF MANAGEMENT ACCOUNTING

Despite the development of Management Accounting as an effective discipline to

improve the managerial performance, some of the limitations are as under:1. Accuracy is not Ensured: Management Accounting is largely based on estimates. It does not deal with actual, alone, and thus total accuracy is not ensured under Management Accounting.2. A Tool in the Hands of Management: Management Accounting is definitely a tool in the hands of management, but cannot replace management.3. Strength and Weakness: Management Accounting derives information from Financial Accounting, Cost Accounting and other records. The strength and weakness of these basic information providers become the strength and weakness of Management Accounting too.4. Costly Affair: The installation of Management Accounting is a costly affair so all the organizations, in particular, small firms cannot afford.5. Lack of Knowledge and Understanding: The emergence of Management Accounting is the fusion of a number of subjects like statistics, economics, engineering and management theory. Any inadequate grounding in any one or more of the subjects is bound to have an unfavourable effect on the consideration and solution of the problems, relating to management performance.6. Evolutionary Stage: Comparatively, Management Accounting is a new discipline and is still very much in a stage of evolution. Therefore, it comes across the same difficulties or obstacles, which a relatively new discipline has to face.7. Psychological Resistance: Adoption of a system of Management Accounting brings about a radical change in the established pattern of the activity of the management personnel. It calls for rearrangement of personnel as well as their activities. This is bound to encounter opposition from some quarter or other.

1.7 RELATIONSHIP BETWEEN MANAGEMENT ACCOUNTING AND COST

ACCOUNTING

Relationship between Management Accounting and Cost Accounting:

Management Accounting is primarily concerned with the requirements of themanagement. It involves application of appropriate techniques and concepts, which helpmanagement in establishing a plan for reasonable economic objective. It helps in makingrational decisions for accomplishment of management objectives. Any workable conceptor techniques whether it is drawn from Cost Accounting, Financial Accounting,Economics, Mathematics and statistics, can be used in Management Accountancy. Thedata used in Management Accountancy should satisfy only one broad test. It shouldserve the purpose that it is intended for. A management accountant accumulates,summarises and analysis the available data and presents it in relation to specificproblems, decisions and day-to-day task of management. A management accountantreviews all the decisions and analysis from management‘s point of view to determinehow these decisions and analysis contribute to overall organisational objectives. Amanagement accountant judges the relevance and adequacy of available data frommanagement‘s point of view.

The scope of Management Accounting is broader than the scope of Cost Accountancy. In CostAccounting, primary emphasis is on cost and it deals with its collection, analysis, relevanceinterpretation and presentation for various problems of management. Management COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT 7Accountancy utilizes the principles and practices of Financial Accounting and Cost Accountingin addition to other management techniques for efficient operations of a company. It widelyuses different techniques from various branches of knowledge like Statistics, Mathematics,Economics, Laws and Psychology to assist the management in its task of maximising profitsor minimizing losses. The main thrust in Management Accountancy is towards determiningpolicy and formulating plans to achieve desired objective of management. ManagementAccountancy makes corporate planning and strategy effective.

From the above discussion we may conclude that the Cost Accounting and ManagementAccounting are interdependent, greatly related and inseparable.

Self Learning Questions:

1. Define management accounting and state its significance?

2. Discuss the role of management accounting in management process.3. Describe the functions of management accounting.4. List down the limitation of management accounting.5. State the relationship between management accounting and cost accounting.

Multiple Choice Questions:

1. Planning and control are done by

A. top management B. lowest level of management C. all levels of management D. None of the above2. Decision-making concerns the A. Past B. Future C. Past and future both D. None of the above3. The comparison of actual results with expected results is referred to as A. Feedback B. Controlling C. None4. Decision-making is involved in the following function/s of management A. Planning B. Organizing C. Controlling D. All the above functions5. This function works like a policeman to ensure the performance of the employees: A. Controlling B. Planning C. Organizing D. None of these6. The use of management accounting is A. Compulsory B. Optional C. Mandatory as per the law

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 8 D. None of the above7. Management Accounting relates to A. Collection of data from different sources B. Modification of data to meet the specific needs C. Presentation of data D. All of the above8. Division of Accounting is divided into A. 2 B. 3 C. 4 D. None of the above

[Ans: 1. (a) 2. (b) 3. (a) 4. (d) 5 (a) 6. (b) 7. (d) 8. (b)]

Match the followings:

Column A Column B 1 Management Accounting is a tool to. A Effective and efficient 2 Management accounting is composed B Planning, Organising, Controlling and of. Decision making 3 Organisation has to be both C Maximisation of profit and minimisation of losses. 4 Objective of management Accounting D Management 5 Function of Management E Management and Accounting

[Ans: D, E, A, C, B]

State whether the following statement is True or False:

1. Any form of accounting, which enables a business to be conducted more efficiently

can be regarded as Management Accounting.2. Standard formats are used in management accounting for preparation of reports.3. In Management Accounting, Generally Accepted Accounting Principles and Practices of Accounting govern the preparation of reports.4. It is optional for a company to have financial accounting5. Management Accounting reports are public documents

[Ans: 1. True, 2. False, 3. False, 4.

False, 5. False] Fill in the blanks:

1. Decision-making is a process of choosing among ___________ alternatives.

2.1 MARGINAL COSTING

The cost of a product or process can be ascertained using different elements of costusing any of the following two techniques viz.,1. Absorption Costing2. Marginal Costing

Absorption CostingUnder this method, the cost of the product is determined after considering the total costi.e., both fixed and variable costs. Thus this technique is also called traditional or totalcosting. The variable costs are directly charged to the products where as the fixed costsare apportioned over different products on a suitable basis, manufactured during aperiod. Thus under absorption costing, all costs are identified with the manufacturedproducts.

Limitations of Absorption Costing:

1. Being dependent on levels of output which vary from period to period, costs are vitiated due to the existence of fixed overhead. This renders them useless for purposes of comparison and control. (If, however, overhead recovery rate is based on normal capacity, this situation will not arise).2. Carryover of a portion of fixed costs, i.e., period costs to subsequent accounting periods as part of the cost of inventory is a unsound practice because costs pertaining to a period should not be allowed to be vitiated by the inclusion of costs pertaining to the previous period.3. Profits and losses in the accounts are related not only to sales but also to production, including the product which is unsold. This is contrary to the principle that profits are made not at the stage when products are manufactured but only when they are sold.4. There is no uniformity in the methods of application of overhead in absorption costing. These problems have, no doubt, to be faced in the case of marginal costing also but to a less extent of fixed overhead will not arise in the case of marginal costing.5. Absorption costing is not always suitable for decision making solution to various types of problems of management decision making, where the absorption cost method would be practically ineffective, such as selection of production volume and optimum capacity

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 10 utilization, selection of production mix, whether to buy or manufacture, choice of alternatives and evaluation of performance can be had with the help of marginal cost analysis. Sometimes, the conclusion drawn from absorption cost data in this regard may be misleading and lead to losses.

Marginal CostingMarginal costing is ―the ascertainment of marginal costs and of the effect on profit ofchanges in volume or type of output by differentiating between fixed costs and variablecosts.‖ Several other terms in use like direct costing, contributory costing, variable costing,comparative costing, differential costing and incremental costing are used more or lesssynonymously with marginal costing.It is a process whereby costs are classified into fixed and variable and with such adivision so many managerial decisions are taken. The essential feature of marginalcosting is division of total costs into fixed and variable, without which this could not haveexisted. Variable costs vary with volume of production or output, whereas fixed costsremains unchanged irrespective of changes in the volume of output. It is to beunderstood that unit variable cost remains same at different levels of output and totalvariable cost changes in direct proportion with the number of units. On the other hand,total fixed cost remains same disregard of changes in units, while there is inverserelationship between the fixed cost per unit and the number of units.

Features of Marginal Costing:

The main features of Marginal Costing may be summed up as follows:1. Appropriate and accurate division of total cost into fixed and variable by picking out variable portion of semi variable costs also.2. Valuation of stocks such as finished goods, work-in-progress is valued at variable cost only.3. The fixed costs are written off soon after they are incurred and do not find place in product cost or inventories.4. Prices are based on Marginal Cost and Marginal Contribution.5. It combines the techniques of cost recording and cost reporting.

Advantages or Merits or Applications of Marginal Costing:

1. Marginal costing system is simple to operate than absorption costing because they do not involve the problems of overhead apportionment and recovery.2. Marginal costing avoids, the difficulties of having to explain the purpose and basis of overhead absorption to management that accompany absorption costing. Fluctuations in profit are easier to explain because they result from cost volume interactions and not from changes in inventory valuation.3. It is easier to make decisions on the basis of marginal cost presentations, e.g., marginal costing shows which products are making a contribution and which are failing to cover their avoidable (i.e., variable) costs. Under absorption costing the relevant information is difficult to gather, and there is the added danger that management may be misled by reliance on unit costs that contain an element of fixed cost.4. Marginal costing is essentially useful to management as a technique in cost analysis and cost presentation. It enables the presentation of data in a manner useful to different levels of management for the purpose of controlling costs. Therefore, it is an important technique in cost control.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 115. Future profit planning of the business enterprises can well be carried out by marginal costing. The contribution ratio and marginal cost ratios are very useful to ascertain the changes in selling price, variable cost etc. Thus, marginal costing is greatly helpful in profit planning.6. When a business concern consists of several units and produces several products and evaluation of performance of such components can well be made with the help of marginal costing.7. It is helpful in forecasting.8. When there are different products, the determination of number of units of each product, called Optimum Product Mix, is made with the help of marginal costing.9. Similarly, optimum sales mix i.e., sales of each and every product to get maximum profit can also be determined with the help of marginal costing.10. Apart from the above, numerous managerial decisions can be taken with the help of marginal costing, some of which, may be as follows:- a) Make or buy decisions, b) Exploring foreign markets, c) Accept an order or not, d) Determination of selling price in different conditions, e) Replace one product with some other product, f) Optimum utilisation of labour or machine hours, g) Evaluation of alternative choices, h) Subcontract some of the production processes or not, i) Expand the business or not, j) Diversification, k) Shutdown or continue,

Limitations of Marginal Costing:

(a) The separation of costs into fixed and variable present‘s technical difficulties and no variable cost is completely variable nor is a fixed cost completely fixed.(b) Under the marginal cost system, stock of finished goods and work-in-progress are understated. After all, fixed costs are incurred in order to manufacture products and as such, these should form a part of the cost of the products. It is, therefore, not correct to eliminate fixed costs from finished stock and work-in-progress.(c) The exclusion of fixed overhead from the inventories affects the Profit and Loss Account and produces an unrealistic and conservative Balance Sheet, unless adjustments are made in the financial accounts at the end of the period.(d) In marginal costing system, marginal contribution and profits increase or decrease with changes in sales volume. Where sales are seasonal, profits fluctuate from period to period. Monthly operating statements under the marginal costing system will not, therefore, be as realistic or useful as in absorption costing.(e) During the earlier stages of a period of recession, the low profits or increase in losses, as revealed in a magnified way in the marginal costs statements, may unduly create panic and compel the management to take action that may lead to further depression of the market.(f) Marginal costing does not give full information. For example, increased production and sales may be due to extensive use of existing equipments (by working overtime or in shifts), or by an expansion of the resources, or by the replacement of labour force by machines. The marginal contribution fails to reveal these. COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT 12(g) Though for short-term assessment of profitability marginal costs may be useful, long term profit is correctly determined on full costs basis only.(h) Although marginal costing eliminates the difficulties involved in the apportionment and under and over-absorption of fixed overhead, the problem still remains so far as the variable overhead is concerned.(i) With increased automation and technological developments, the impact on fixed costs on products is much more than that of variable costs. A system which ignores fixed costs is therefore, less effective because a major portion of the cost, such as not taken care of.(j) Marginal costing does not provide any standard for the evaluation of performance. A system of budgetary control and standard costing provides more effective control than that obtained by marginal costing.

2.2 TOOLS AND TECHNIQUES OF MARGINAL COSTING

1. Contribution:In common parlance, contribution is the reward for the efforts of the entrepreneur orowner of a business concern. From this, one can get in his mind that contribution meansprofit. But it is not so. Technically or in Costing terminology, contribution means not onlyprofit but also fixed cost. That is why; it is defined as the amount recovered towards fixedcost and profit.

Contribution can be computed by subtracting variable cost from sales or by adding fixedcosts and profit.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 13In the above example, one can say that the product ‗C‘ is more profitable because, it hasmore contribution. This proposition of product having more contribution is moreprofitable is valid, as long as, there are no limitations on any factor of production. In thiscontext, factors of production means, the factors that are responsible for producing theproducts such as materials, labour, machine hours, demand for sales etc.,

Limiting Factor (or) Key Factor:

In the above example, we find that product having more contribution is more profitable.However, when there is a limitation on any input factor, the profitability of the productcannot simply be determined by finding out the contribution of the unit, but it can befound out by ascertaining the contribution per unit of that factor of production which islimited in the given situation. Such factor of production which is limited in the question iscalled key factor or limiting factor.

Continuing the above example, it may be explained as follows:

The three products take some raw material. A takes 1 kg, B requires 2 kgs, C requires 5kgs and the raw material is not abundant.

Then profitability of the above products is determined as flows:

Now, product A is more profitable because it has more contribution per kg of material.

Key factor can also be called as scarce factor or Governing factor or Limiting factor orConstraining factor etc., whatever may be the name, it indicates the limitation on theparticular factor of production.

From the above, it is essentially understandable that contribution is helpful in

determination of profitability of the products, priorities for profitability of the product andin particular, profitabilities when there are limitation on any factor.

2. Profit Volume Ratio (P/V Ratio) or contribution Ratio:

First of all, a ratio is a statistical or mathematical tool with the help of which arelationship can be established between the variables of the same kind. Further, it maybe expressed in different forms such as fractional form, quotient, percentage, decimalform, and proportional form.For Example:

Gross Profit Ratio: It may be expressed as follows:

 Gross profit is ¼th of sales

 Sales is 4 times that of gross profit Gross profit ratio is 25% Gross profit is 0.25 of sales and lastly Gross profit and sales are in the ratio of 1 : 4

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 14So, P/V ratio or contribution ratio is association of two variables. From this, one mayassume that it is the ratio of profit and sales. But it is not so. It is the ratio of Contributionto Sales.

It is to be noted that the above two formulas are valid as long as there are no changes inprices, means input prices and selling prices.

Usually, Sales = Cost + Profit.

i.e., it can also be written as Sales = Variable Cost + Fixed Cost + Profit and this is calledgeneral sales equation.

Since Sales consists of variable costs and contribution, given the variable cost ratio, P/Vratio can be found out. Similarly, given the P/V ratio, variable cost ratio can be found out.

For example, P/V ratio is 40%, then variable cost ratio is 60%, given variable cost ratiois 70%, then P/V ratio is 30%. Such a relationship is called complementary relationship.Thus P/V ratio and variable cost ratios are said to be complements of each other.

P/V ratio is also useful like contribution for determination of profitabilities of the productsas well as the priorities for profitabilities of the products. In particular, it is useful indetermination of profitabilities of the products in the following two situations:(i) When sales potential in value is limited.(ii) When there is a greater demand for the products.

Break Even Analysis:

When someone asks a layman about his business he may reply that it is alright. But atechnical man may reply that it is break even. So, Break Even means the volume ofproduction or sales where there is no profit or loss. In other words, Break Even Point isthe volume of production or sales where total costs are equal to revenue. It helps infinding out the relationship of costs and revenues to output. In understanding thebreakeven point, cost, volume and profit are always used. The break even analysis isused to answer many questions of the management in day to day business.COST & MANAGEMENT ACCOUNTING AND FINANCIALMANAGEMENT 15The formal break even chart is as follows:

a = Losses b = Profits

When no. of units are expressed on X-axis and costs and revenues are expressed on Y-axis, three lines are drawn i.e., fixed cost line, total cost line and total sales line. In theabove graph we find there is an intersection point of the total sales line and total cost lineand from that intersection point if a perpendicular is drawn to X-axis, we find break evenunits. Similarly, from the same intersection point a parallel line is drawn to X-axis so thatit cuts Y-axis, where we find Break Even point in terms of value. This is how, the formalpictorial representation of the Break Even chart.

At the intersection point of the total cost line and total sales line, an angle is formedcalledAngle of Incidence, which is explained as follows:

Angle of Incidence:Angle of Incidence is an angle formed at the intersection point of total sales line and totalcost line in a formal break even chart. If the angle is larger, the rate of growth of profit ishigher and if the angle is lower, the rate of growth of profit is lower. So, growth of profitor profitability rate is depicted by Angle of Incidence.

Break Even Analysis (or) Cost-Volume-Profit Analysis (CVP analysis):

From the breakeven charts breakeven point and profits at a glance can be found out.Besides, management makes profit planning with the help of breakeven charts. It canclearly be understood by way of charts to know the changes in profit due to changes incosts and output. Such profit planning is made with the variables mainly cost, profit andvolume, such an analysis is called breakeven analysis. Throughout the charts relationshipis established among the cost, volume and profit, it is also called Cost-Volume-ProfitAnalysis (CVP analysis).That is why it is popularly said by S. C. Kuchal in his book ―Financial Management - AnAnalytical and Conceptual Approach‖, that Cost-volume-profit analysis, break evenanalysis and profit graphs are interchangeable words. The analysis is furtherexplained as follows:

The change in profit can be studied through Break even charts in different situations inthe following manner:

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 16i) Increase in No. of Units

Units

‗……‘ line indicates increase in total cost and total sales.

In the above chart, if we clearly observe we find that there is no change in BEP even if there is increase or decrease in No. of units.

ii) Increase in Sales due to increase in selling price.

NTS = New Total Sales line

‗……‘ line indicates changes in breakeven point and changes in sales.

From the above chart, we observe that profit is increased by increasing the selling price and also, if there is change in selling price, BEP also changes. If selling price is increased then BEP decreases.

If selling price is decreased then BEP increases. Thus, we say that there is an inverse relationship between selling price and BEP.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 17iii) Decrease in variable cost:

‗……‘ line indicates decrease in total cost and decrease in B.E.P

From the above chart, we observe that when variable costs are decreased, no doubt, profit is increased. If there is change in variable cost then BEP also changes. If variable cost is decreased then BEP also decreases. If variable cost is increased then BEP also increases. Thus there is direct relationship between variable cost and BEP.

iv) Change in fixed cost:

‗……‘ line indicates decrease in fixed cost and total cost and also decrease in BEP. NTC = New Total Cost Line NFC = New Fixed Cost Line From the above chart also we find that there is increase in profit due to decrease in fixed cost. If fixed cost is increased then BEP also increases. If fixed cost is decreased then BEP also decreases. Thus there is a direct relationship between fixed cost and BEP.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 18Non linear Break Even Chart:

In some cases on account of non-linear behaviour of cost and sales there may be two ormore break even points. In such a case the optimum profit is earned where the differencebetween the sales and the total costs is the largest. It is obvious that the business shouldproduce only upto this level. This is being illustrated in the above chart.

Cash Break-Even Point:

When break-even point is calculated only with those fixed costs which are payable incash, such a break-even point is known as cash break-even point. This means thatdepreciation and other non-cash fixed costs are excluded from the fixed costs incomputing cash break-even point. Its formula is-Cash breakeven point = Cash fixed costs / Contribution per unit.

Profit Volume Chart:

Profit-volume chart prominently exhibits the relationship between profit and salesvolume. The normal break-even charts suffer from one limitation. Profit cannot be readdirectly from the chart. It is essential to deduct total cost from sale to know the profitfigure. The profit graph overcomes the difficulty by plotting profit directly against anactivity. These charts are easy to understand and their preparation involves drawingsales curve and profit curve. The point at which profit line cuts the sales line is calledbreak-even point. Taking the methods and objects under consideration, the profit-volumechat can be further divided into following categories i.e.,

(a) Simple Profit-Volume Chart:

Its preparation involves the following steps: Finding out profit at any two levels of activity. Drawing sales line. Drawing profit line.

Simple Profit-Volume chart is shown below:

Sequential Profit Graph:

Sometimes, a company manufactures more than one product of varying profitability. Achange in the profitability of one product will lead to a change in the profitability as awhole. Profit-volume chart can be prepared for a group also. This chart shows relativeprofitability of different products. It is also called profit-volume graph for a group ofproducts, sequential profit graph or profit path chart. Its main advantage is that itexhibits the relative profitability of different products at a glance. This graph is alsouseful to show average slope and marginal slope.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 20Methods of drawing ‗Profit Path‘:In sequential profit graph or profit graph for a group of products, a line ―profit plan‖ is drawn in orderto draw total profit line. For drawing profit path, a statement is prepared showingcumulative sale and cumulative profit. The line ‗Profit path‘ is drawn with the aid of columns forcumulative same and cumulative profit.

Steps in drawing Profit volume graph (or) sequential profit graph:

 First prepare a marginal cost statement to know the P/V ratios. Prepare a statement to find out cumulative sale and cumulative profit. Draw a profit path with the help of columns, cumulative sale and cumulative profit. Draw total profit line for group of products.

Fixed CostNo. of Units Contribution per Contribution PerUnit UnitBreak even salesSU (Sales) F×= S S-VUses and applications of Break even Analysis (Or) Profit Charts (Or) CostVolume Profit Analysis:The important uses to which cost-volume profit analysis or break-even analysis or profitcharts may be put to use are:(a) Forecasting costs and profits as a result of change in Volume determination of costs, revenue and variable cost per unit at various levels of output.(b) Fixation of sales Volume level to earn or cover given revenue, return on capital employed, or rate of dividend.(c) Determination of effect of change in Volume due to plant expansion or acceptance of order, with or without increase in costs or in other words, determination of the quantum of profit to be obtained with increased or decreased volume of sales.(d) Determination of comparative profitability of each product line, project or profit plan.(e) Suggestion for shift in sales mix.(f) Determination of optimum sales volume.(g) Evaluating the effect of reduction or increase in price, or price differentiation in different markets.(h) Highlighting the impact of increase or decrease in fixed and variable costs on profit.(i) Studying the effect of costs having a high proportion of fixed costs and low variable costs and vice-versa.(j) Inter-firm comparison of profitability.(k) Determination of sale price which would give a desired profit for break-even.(l) Determination of the cash requirements as a desired volume of output, with the help of cash breakeven charts.(m)Break-even analysis emphasizes the importance of capacity utilization for achieving economy.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL 22

MANAGEMENT(n) During severe recession, the comparative effects of a shutdown or continued operation at a loss are indicated.(o) The effect on total cost of a change in the fixed overhead is more clearly demonstrated through break-even charts.

Limitations of Break-even Analysis:

(a) That Costs are either fixed or variable and all costs are clearly segregated into their fixed and variable elements. This cannot possibly be done accurately and the difficulties and complications involved in such segregation make the break-even point inaccurate.(b) That the behavior of both costs and revenue is not entirely related to changes in volume.(c) That costs and revenue patterns are linear over levels of output being considered. In practice, this is not always so and the linear relationship is true only within a short run relevant range.(d) That fixed costs remain constant and variable costs vary in proportion to the volume. Fixed costs are constant only within a limited range and are liable to change at varying levels of activity and also over a long period, particularly when additional plants and equipments are introduced.(e) That sales mix is constant or only one product is manufactured. A combined analysis taking all the products of the mix does not reflect the correct position regarding individual products.(f) That production and sales figures are identical or the change in opening and closing stocks of the finished product is not significant.(g) That the units of production on the various product range are identical. Otherwise, it is difficult to find a homogeneous factor to represent volume.(h) That the activities and productivity of the concern remain unchanged during the period of study.(i) As output is continuously varied within a limited range, the contribution margin remains relatively constant. This is possible mainly where the output is more or less homogeneous as in the case of process industries

2.3 DIFFERENTIAL COST ANALYSIS

Differential Cost is the change in the costs which results from the adoption of analternative course of action. The alternative actions may arise due to change in salesvolume, price, product mix (by increasing, reducing or stopping the production of certainitems), or methods of production, sales, or sales promotion, or they may be due to ‗makeor buy‘ or ‗take or refuse‘ decisions. When the change in costs occurs due to change inthe activity from one level to another, differential cost is referred to as incremental costor decremental cost, if a decrease in output is being considered, i.e. total increase in costdivided by the total increase in output. However, accountants generally do notdistinguish between differential cost and incremental cost and the two terms are used tomean one and the same thing.

The computation of differential cost provides an useful method of analysis for themanagement for anticipating the results of any contemplated changes in the level ornature of activity. When policy decisions have to be taken, differential costs worked outon the basis of alternative proposals are of great assistance.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 23The determination of differential cost is simple. Differential cost represents the algebraicdifference between the relevant costs for the alternatives being considered. Thus, whentwo levels of activities are being considered, the differential cost is obtained bysubtracting the cost at one level from the cost of another level.

The essential features of differential costs are as follows:-

1) The basis data used for differential cost analysis are costs, revenue and the investment factors which are relevant in the problem for which the analysis is undertaken.2) Total differential costs rather than the costs per unit are considered.3) Differential cost analysis is made outside the accounting records.4) As the differences in the costs at two levels are considered, absolute costs at each level are not as relevant as the difference between the two. Thus, items of costs which do not change but are identical for the alternatives under consideration, are ignored.5) The differentials are measured from a common base point or position.6) The stage at which the difference between the revenue and the cost is the highest, measured from the common base point, determines the choice from amongst a number of alternative actions.7) In computing differential costs, historical or standard costs may be used but they should be adjusted to the requirements of future conditions.8) The elements and items of cost to be considered in differential cost analysis will depend upon the nature of the problem and the alternatives being considered.

Differential Costs Analysis and Marginal Costing:

Although the techniques of differential costs analysis are similar to those of marginalcosting, the two should not be confused. The points of similarity and difference betweendifferential costs analysis and marginal costing are summarized below:

Similarity:(a) Both the techniques of cost analysis and cost presentation.(b) Both are made use of by the management in decision making and in formulating policies.(c) The concepts of differential costs and marginal costs mainly arise out of the difference in the behaviour of fixed and variable costs.(b) Differential costs compare favourably with the economist‘s definition of marginal cost, viz. That marginal cost is the amount which at any given volume of output is changed if output is increased or decreased by one unit.

Difference:(a) Differential cost analysis can be made in the case of both absorption costing as well as marginal costing.(b) While marginal costing excludes the entire fixed costs, some of the fixed costs may be taken into account as being relevant for the purpose of differential cost analysis.(c) Marginal costs may be embodied in the accounting system whereas differential costs are worked out separately as analysis statements.(d) In marginal costing, margin of contribution and contribution ratio are the main yardsticks for performance evaluation and for decision making. In differential cost analysis, differential costs are compared with the incremental or decremental revenues, as the case may be.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 24Practical Application of Differential Costs:They are useful in managerial decisions, which are enumerated below:(i) Determination of most profitable levels of production and price.(ii) Acceptance of offer at a lower price or offering a quotation at lower selling price in order to increase capacity.(iii) It is used to decide whether it will be more profitable to sell a product as it is or to process it further into a different product to be sold at an increased price.(iv) Determining the suitable price at which raw material may be purchased.(v) Decision of adding a new product or business segment.(vi) Discontinuing a product or business segment in order to avoid or reduce the present loss or increase profit.(vii) Changing the product mix.(viii) Make or buy decisions.(ix) Decision regarding alternative capital investment and plant replacement.(x) Decision regarding change in method of production.

2.4 DIFFERENCES BETWEEN ABSORPTION COSTING AND MARGINAL COSTING

Absorption Costing Marginal Costing

1. Both fixed and variable costs are Only variable costs are considered for considered for product costing and product costing and inventory valuation. inventory valuation. 2. Fixed costs are charged to the cost of Fixed costs are regarded as period costs. The profitability of different products production. Each product bears a is reasonable share of fixed cost and thus the judged by their P/V ratio. profitability of a product is influenced by the apportionment of fixed costs. 3. Cost data are presented in conventional Cost data are presented to highlight the pattern. Net profit of each product is total contribution of each product. determined after subtracting fixed cost along with their variable cost. 4. The difference in the magnitude of The difference in the magnitude of opening stock and closing stock affects opening stock and closing stock does the unit cost of production due to the not affect the unit cost of production. impact of related fixed cost. 5. In case of absorption costing the cost per In case of marginal costing the cost per unit remains the same, irrespective of unit reduces, as the production increases the as it is fixed cost which reduces, whereas, production as it is valued at variable the variable cost remains the same per cost. unit.

Difference in profit under Marginal and Absorption Costing:

 No opening and closing stock: In this case, profit/loss under absorption and marginal costing will be equal.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

25 When opening stock is equal to closing stock: In this case, profit/loss under two approaches will be equal provided the fixed cost element in both the stocks is same amount. When closing stock is more than opening stock: In other words, when production during a period is more than sales, then profit as per absorption approach will be more than that by marginal approach. The reason behind this difference is that a part of fixed overhead included in closing stock value is carried forward to next accounting period. When opening stock is more than the closing stock: In other words when production is less than the sales, profit shown by marginal costing will be more than that shown by absorption costing. This is because a part of fixed cost from the preceding period is added to the current year‘s cost of goods sold in the form of opening stock.

2.5 APPLICATION OF MARGINAL COSTING IN DECISION MAKING

One of the basic functions of management is to make decisions. Decision making processgenerally involves selecting a course of action from among various alternatives. Some ofthe important areas where marginal costing techniques are generally applied can begiving as follows:

1. Selection of a Profitable Sales mix or Profitable Product mix:

In case of a multi-product concern, there may arise a problem of the selection of thesuitable or profitable sales mix i.e., the determination of the ratio in which variousproducts are produced and sold. For the purpose of determining the profitable sales mix,the amount of contribution available under each alternative of sales mix is to beconsidered and the sales mix giving maximum total contribution will be selected. But thevarious problems arising out of change in the sales mix e.g., limiting factors etc., must beproperly considered.

Hence sales mix under alternative (a) is more profitable as it gives maximum totalcontribution and profit.

2. Problem of Limiting Factors:

Limiting factor (also known as 'key factor') is a factor which limits production and/or salesand thus prevents the manufacturing concern from earning unlimited profits. The limitingfactors or key factors may be shortage of raw material, shortage of skilled labour andmachine

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 27capacity, market for sales etc. In case of the existence of a key factor, a problem mayarise as to which product should be pushed more in order to maximise profits. Selectionof the profitable product shall be made on the basis of the contribution per unit oflimiting factor. The profitability of a product with reference to limiting factor can beassessed as follows:

Profitability = Contribution / Limiting Factor per unit

Illustration 2:In a factory producing two different kinds of articles, the limiting factor is theavailability of labour. From the following information, show which product ismore profitable:

3. Make or Buy Decisions:

Sometimes a manufacturer has to decide as to whether a certain component or sparepart should be manufactured in the factory (having unused installed capacity) or boughtfrom the market. In taking such a 'make or buy ' decision, the marginal cost of thecomponent or spare part should be compared with the market price. If the marginal costis lower than the market price, the component or spare part should be manufactured inthe factory itself. However, the manufacturer must take into consideration any increasein fixed costs or any Limiting factor which may arise if the production is undertaken in thefactory. If the purchase price is lower than the marginal cost and provided regular supplyand proper quality of the component are guaranteed by outside supplier, it should bepurchased from outside supplier.

Illustration 3:A mobile manufacturing company finds that while it costs ` 6.25 each to make acomponentX – 2370, the same is available in the market at ` 5.75 with an assurance ofcontinued supply.The break-down of cost is: Direct materials ` 2.75 each Direct labour ` 1.75 each Other variables ` 0.50 each Depreciation and other fixed cost ` 1.25 each Total ` 6.25 each

(a) Should you make or buy?

(b) What would be your decision if the supplier offers the component at ` 4.85 each?COST & MANAGEMENT ACCOUNTING AND FINANCIALMANAGEMENT 29Solution:

Calculation of Marginal Cost of Component X – 2370

(a) Since the marginal cost per unit of ` 5 is lower than the market price of ` 5.75, it is recommended to manufacture the component in the factory.(b) Since the purchase price of ` 4.85 is lower than the marginal cost, the component should be bought from outside supplier provided proper quality and regular supply are guaranteed.

4. Diversification of Production:Sometimes a manufacturer may intend to add a new product to the existing product orproducts to utilize the idle capacity, to capture a new market or for some other purpose.In such a case, the manufacturer or management is interested in knowing theprofitability of the new product before its production can be undertaken. It is advisable eto undertake the production of the new product if it is capable of contributing somethingtowards fixed costs and profit after meeting out its variable Cost of sales. Fixed costs arenot to be considered on the assumption that the new product ca n be manufactured byexisting resources without incurring any additional fixed costs. But if the introduction of anew product involves some specific or identifiable fixed costs (which arise due to the newproduct), these should be deducted from the contribution of the new product beforemaking any decision.But if the introduction of a new product involves some specific or identifiable fixed costs(which arise due to the new product), these should be deducted from the contribution ofthe new product before making any decision.

Illustration 4:The following data are available in respect of product ‗A‘ manufactured byPankaj Ltd.: ` Sales 2,50,000 Direct materials 1,00,000 Direct wages 50,000 Variable overhead 25,000 Fixed overhead 50,000The company now proposes to introduce a new product ‗B‘ so that sales maybe increased by ` 50,000. There will be no increase in fixed costs and theestimated variable costs of the product ‗B‘ are: ` Direct materials 24,000 Direct wages 11,000 Overhead 7,000Advise whether product B will be profitable or not.

Assuming that spare capacity cannot be used for any other purpose (except forproducing product ‗B‘), it is advisable to undertake the production of product ‗B‘ whichshall give a contribution of ` 8,000 towards fixed costs and profit.

5. Fixation of Selling price:

Marginal costing techniques assist the management in the fixation of the selling price ofdifferent products. Marginal cost of a product is the guiding factor in the fixation of sellingprice. Generally, the selling price of a product is fixed at a level which not only covers themarginal cost but also contributes something towards fixed costs. Hence, under normalcircumstances for a long period, the fixation of selling price is done on the basis of thetotal cost of sales (i.e., by adding some margin of profit to the total cost).

But in times of cut-throat competition, trade depression, in accepting additional orders

for utilizing unused capacity and in exploring foreign markets, the manufacturer may beready to sell hi s products at a price below total cost but not at a price below marginalcost. For fixing the price at a level below total cost of sales, the manufacturer shall takeinto account the overall profitability or P/V Ratio of the business concern. Thus, thefixation of selling price becomes easy where marginal cost, overall P/V Ratio and thelevel of profits expected, are known. In case of exports to foreign markets, the effect ofvarious direct and indirect benefits such as cash compensatory assistance, subsidies,import entitlements and other special favours or benefits from the Government shouldalso be taken into account.

Further, pricing at or below marginal costs may be considered desirable for a Shorterperiod under certain special circumstances given below:

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 31(i) To introduce a new product in the market or to popularize it.(ii) To drive out weaker competitors from the market.(iii) To maintain production in order to avoid retrenchment of employees.(iv) To keep the plant and machinery in gear.(v) To avoid the loss of future markets.(vi) To sell the goods of perishable nature.(vii) To push up the sales of other conjoined profitable products.Illustration 5:P. Co. Ltd., has an overall P/V Ratio of 60%. If the variable cost of a product is `20, what will be its selling price?Solution:

Overall P/V Ration of the company = 60%

P/V Ratio = Contribution = Sales - Variable Cost Sales SalesIf selling price is assumed to be 100.Contribution = 60Variable Cost = 100 – 60 = 40Thus, when variable cost is 40, selling price = 100 100When variable cost is 1 selling price will be = 40 100When variable cost is 20, selling price will be = 40 × 20 = ` 50.Export Market vs. Home Market:A firm engaged in supplying goods in the home market and having surplus productioncapacity, may think of utilising it to meet export orders at a price lower than thatprevailing in the home market. Such a decision is made only when the local sale isearning a profit i.e., when it fixed costs have already been recovered by the local sales. Insuch cases, if the export price is more than the marginal cost, it is advisable to enter theexport market. Any reduction in the selling price in the local market to utilise the surpluscapacity may adversely affect the normal local sales.However, dumping in the export market at a lower price even below marginal cost inorder to capture future market, has no adverse effect on local sales.Illustration 6:Indo-US Company has a capacity to produce 5,000 articles but actuallyproduced only 2,000articles for home market at the following costs: ` Materials 40,000 Wages 36,000 Factory Overheads: Fixed 12,000 Variable 20,000 Administration overhead (Fixed) 18,000 Selling and Distribution overhead: Fixed 10,000 Variable 16,000 1,52,000

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 32The home market can consume only 2,000 articles at a selling price of ` 80 perarticle. An additional order for the supply of 3,000 articles is received from aforeign customer at ` 65 per article. Should this order be accepted or not?

Since there is a profit of ` 8,000 at the existing level of 2,000 articles sold in the homemarket, the fixed costs are fully recovered.

6. Alternative Methods of Manufacture:

Sometimes a manufacturer is faced with the problem of the application of alternativemethods of manufacture i.e., whether machine work or hand work, employment of hand-driven machine or power-driven machine or employment of one machine or anothermachine etc. For the purpose of selecting the method of production to be adopted, acomparison of the amount of contribution available under different methods ofmanufacture shall be made. The alternative providing the maximum contribution per unitshall be considered to be more profitable. However, the limiting factor. If any, involved inthe method of production, must be given proper consideration.

Illustration 7:Product ‗A‘ can be manufactured either by Machine No. 1 or by Machine No. 2.Machine No. 1 can produce 10 units of ‗A‘ per hour and Machine No. 2, 20 unitsper hour. Total machine hours available are 3,000 hours per annum. Taking intoaccount the following comparative costs and selling price, determine theprofitable method of manufacture:

7. Operate or Shut down Decision:

In case of a multi-product concern, it may be found that the production of some of itsproducts is being carried on at a loss. Under such a position, the production of non-profitable products shall have to be discontinued. But if the choice is out of two or moreproducts, the decision shall be taken with reference to the amount of contribution or P/VRatio of these products. Production of the product giving the least amount of contributionor least PN Ratio should be discontinued on the assumption that production capacity thusfreed can be used to produce other profitable products.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 34(i) The firm wishes to give up one of the products. Which product should be given up, assuming that the plant and labour thus freed can be used to produce the other products?(ii) Will it make any difference to you answer if you are told that the time required to produce the three products is 4 hours, 6 hours, and 8 hours respectively.

Since the selling prices of three products are not equal, the decision regarding giving upthe production of one of the products is to be taken with reference to the P/V Ratioavailable. Since product Z shows the least P/V Ratio, it is advisable to give up itsproduction.

(ii) Since the time required to produce the products is given, it shall be treated as limiting factor and the decision is to be taken with reference to the amount of contribution per unit f limiting factor (i.e., per hour).

Product X Product Y Product Z

Production of product ‗C‘ should be discontinued as it gives least amount of contribution

per hour.8. Maintaining a Desired Level of Profit:Sometimes the management may be interested in maintaining a desired level of profitsunder the conditions of a change in the sales price. The volume of sales required to earna desired level of profits can be ascertained by applying marginal costing techniques. Forascertaining the sales required earning a desired level of profits, the following formulaeare applied: Number of Units to be sold to earn Desired Total Fixed Cost + Desired(i) Profits = Profits Contribution Per Unit Sales value required to earn Desired Profits Total Fixed Cost + Desired(ii) = Profits P/ V Ratios

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 35Illustration 9:A company produces and markets industrial containers and packing cases. Dueto competition, the company proposes to reduce the selling price. If thepresent level of profit is to be maintained, indicate the number of units to besold if the proposed reduction in selling price is:(a) 5%; (b) 10%; (c) 15%.The following additional information isavailable:

9. Alternate Courses of Action:

Sometimes the management has to select a course of action from amongst variousalternative courses. Each course of action has its own merits and limitations. The courseof action to be selected should ensure maximum profit to the business concern. Theappraisal of the various courses of action available is possible through the analysis ofcontribution. The course of action ensuring highest contribution is generally adopted bythe management.COST & MANAGEMENT ACCOUNTING AND FINANCIALMANAGEMENT 36Illustration 10:Excel Ltd. manufactures and markets a single product. The following data areavailable: ` Per unitMaterials 16Conversion costs (variable) 12Dealer‘s Margin 4Selling Price 40Fixed cost : ` 5 lakhsPresent Sales: 90,000 unitsCapacity untilisation: 60 per centThere is acute competition. Extra efforts are necessary to sell. Suggestionshave been made for increasing sales:(a) By reducing the sales price by 5 per cent.(b) By increasing dealer‘s margin by 25 per cent on the existing rate.Which of these two suggestions you would recommend if the company desiresto maintain the present product. Give reasons.Solution:

The company should adopt suggestion (b) since it ensures the present profitability of `2,20,000 at a lower level of production activity of 1,02,857 units as compared to1,16,129 units under suggestion (a). It is given that competition is acute.

10. Profit Planning:

Profit planning is one of the important functions of management. It relates to theattainment of maximum profit. Profit planning requires the management to have theproper knowledge of the inter relationship of selling prices, sales volume, variable cost,and fixed costs. Marginal costing helps the management in ascertaining the profitposition at the various levels of operation through the technique of cost volume profitanalysis. Thus, the management can plan its operations at the optimum level whereprofits are maximum.

Introduction and Meaning:

In the modern days, production is on the mass scale due to technological advancementand upgradation. Organisations grow in course of time and for such growingorganisations, decentralization becomes absolutely necessary. It becomes inevitable forsuch organisations to establish separate divisions and departments to ensure smoothworking. Transfer pricing has become necessary in highly decentralized companies wherenumber of divisions/ departments are created as a part and parcel of the decentralizedorganisation. Transfer pricing is one of the tools in the hands of management formeasuring the performance of divisions or departments.

A ‗Transfer Price‘ is that notional value at which goods and services are transferredbetween divisions in a decentralized organisation. Transfer prices are normally set forintermediate products, which are goods, and services that are supplied by the sellingdivision to the buying division. In large organisations, each division is treated as a ‗profitcenter‘ as a part and parcel of decentralization. Their profitability is measured by fixationof ‗transfer price‘ for inter divisional transfers.The transfer price can have impact on the division‘s performance and hence lot of care isto be taken in fixation of the same. The following factors should be taken intoconsideration before fixing the transfer prices.

(1) Transfer price should help in the accurate measurement of divisional performance.(2) It should motivate the divisional managers to maximize the profitability of their divisions.(3) Autonomy and authority of a division should be ensured.(4) Transfer Price should allow ‗Goal Congruence‘ which means that the objectives of divisional managers match with those of the organisation.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 39 2.7 OBJECTIVES OF INTER COMPANY TRANSFER PRICING

The following are the main objectives of intercompany transfer pricing scheme:1. To evaluate the current performance and profitability of each individual unit: This is necessary in order to determine whether a particular unit is competitive and can stand on its working. When the goods are transferred from one department to another, the revenue of one department becomes the cost of another and such inter transfer price affects the reported profits.2. To improve the profit position: Intercompany transfer price will make the unit competitive so that it may maximize its profits and contribute to the overall profits of the organisation.3. To assist in decision making: Correct intercompany transfer price will make the costs of both the units realistic in order to take decisions relating to such problems as make or buy, sell or process further, choice between alternative methods of production.4. For accurate estimation of earnings on proposed investment decisions: When finance is scarce and it is required to determine the allocation of scarce resources between various divisions of the concern taking into consideration their competing claims, then this technique is useful. 2.8 METHODS OF TRANSFER PRICING

It is the notional value of goods and services transferred from one division to otherdivision. In other words, when internal exchange of goods and services take placebetween the different divisions of a firm, they have to be expressed in monetary terms.The monetary amount for those inter divisional exchanges is called as ‗transfer price‘.The determination of transfer prices is an extremely difficult and delicate task as lot ofcomplicated issues are involved in the same. Inter division conflicts are also possible.There are several methods of fixation of ‗Transfer Price‘. They are discussed below.

1. Pricing based on cost.

1. Pricing based on cost: - In these methods, ‗cost‘ is the base and the following methods fall under this category. (a) Actual Cost: - Under this method the actual cost of production is taken as transfer price for inter divisional transfrers. Such actual cost may consist of variable cost or sometimes total costs including fixed costs. (b) Cost Plus: - Under this method, transfer price is fixed by adding a reasonable return on capital employed to the total cost. Thereby the measurement of profit becomes easy. (c) Standard Cost: - Under this method, transfer price is fixed on the basis of standard cost. The difference between the standard cost and the actual cost being variance is

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 40 absorbed by transferring division. This method is simple and easy to follow, but the constant revision of standards is necessary at regular intervals. (d) Marginal Cost: - Under this method, the transfer price is determined on the basis of marginal cost. The reason being fixed cost is in any case unavoidable and hence should not be charged to the buying division. That is why only marginal cost will be taken as transfer price

2. Market price as transfer price: - Under this method, the transfer price will be determined according to the market price prevailing in the market. It acts as a good incentive for efficient production to the selling division and any inefficiency in production and abnormal costs will not be borne by the buying division. The logic used in this method is that if the buying division would have purchased the goods/services from the open market, they would have paid the market price and hence the same price should be paid to the selling division. One of the variation of this method is that from the market price, selling and distribution overheads should be deducted and price thus arrived should be charged as transfer price. The reason behind this is that no selling efforts are required to sale the goods/services to the buying division and therefore these costs should not be charged to the buying division. Market price based transfer price has the following advantages: 1. Actual costs are fluctuating and hence difficult to ascertain. On the other hand market prices can be easily ascertained. 2. Profits resulting from market price based transfer prices are good parameters for performance evaluation of selling and buying divisions. 3. It avoids extensive arbitration system in fixing the transfer prices between the divisions.

However, the market price based transfer pricing has the following limitations: 1. There may be resistance from the buying division. They may question buying from the selling division if in any way they have to pay the market prices. 2. Like cost based prices, market prices may also be fluctuating and hence there may be difficulties in fixation of these prices. 3. Market price is a rather vague term as such prices may be ex-factory price, wholesale price, retail price etc. 4. Market prices may not be available for intermediate products, as these products may not have any market. 5. This method may be difficult to operate if the intermediate product is for captive consumption. 6. Market price may change frequently. 7. Market prices may not be ascertained easily.

3. Negotiated Pricing: - Under this method, the transfer prices may be fixed through negotiations between the selling and the buying division. Sometimes it may happen that the concerned product may be available in the market at a cheaper price than charged by the selling division. In this situation the buying division may be tempted to purchase the product from outside sellers rather than the selling division. Alternatively the selling division may notice that in the outside market, the product is sold at a higher price but the buying division is not ready to pay the market price. Here, the selling division may be reluctant to sell the product to the buying division at a price, which is less than the

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 41 market price. In all these conflicts, the overall profitability of the firm may be affected adversely. Therefore it becomes beneficial for both the divisions to negotiate the prices and arrive at a price, which is mutually beneficial to both the divisions. Such prices are called as ‗Negotiated Prices‘. In order to make these prices effective care should be taken that both, the buyers and sellers should have access to the available data including about the alternatives available if any. Similarly buyers and sellers should be free to deal outside the company, but care should be taken that the overall interest of the organisation is not affected. • The main limitation of this method is that lot of time is spent by both the negotiating parties in fixation of the negotiated prices. • Negotiating skills are required for the managers for arriving at a mutually acceptable price, otherwise there is a possibility of conflicts between the divisions.

4. Pricing based on opportunity cost: - This pricing recognizes the minimum price that the selling division is ready to accept and the maximum price that the buying division is ready to pay. The final transfer price may be based on these minimum expectations of both the divisions. The most ideal situation will be when the minimum price expected by the selling division is less than the maximum price accepted by the buying division. However in practice, it may happen very rarely and there is possibility of conflicts over the opportunity cost.

It is very clear that fixation of transfer prices is a very delicate decision. There might be clash of interests between the selling and buying division and hence while fixing the transfer price, overall interests of the organisation should be taken into consideration and overall ‗Goal Congruence‘ should be given utmost importance rather than interests of the selling or buying division.

The amount of divisional investment is `1, 50,000 and the minimum desiredrate of return on the investment is the cost of capital of 20%.Calculate(i) Divisional expected ROI and(ii) Divisional expected RI

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 42Illustration 13:A company has two divisions, X and Y. Division X manufactures a componentwhich is used by Division Y to produce a finished product. For the next period,output and costs have been budgeted as follows. Particulars Division X Division Y Component units 50,000 --- Finished units --- 50,000 Total variable costs – Rupees 2,50,000 6,00,000 Fixed Costs Rupees 1,50,000 2,00,000The fixed costs are separable for each division. You are required to advise onthe transfer price to be fixed for Division X‘s component under the followingcircumstances.A. Division A can sell the component in a competitive market for ` 10 per unit. Division Y can also purchase the component from the open market at that price.B. As per the situation mentioned in (A) above, and further assume that Division Y currently buys the component from an external supplier at the market price of ` 10 and there is reciprocal agreement between the external supplier and another Division Z, within the same group. Under this agreement, the external supplier agrees to buy one product unit from Division Z at a profit of ` 4 per unit to that division, for every component which Division B buys from the sup.Solution:

Transfer price decisions can be taken on the following basis.

A. Transfer Price: - Marginal Cost + Opportunity Cost i.e. ` (5 + 5) = ` 10 Note: Marginal Cost = ` 2, 50,000 / 50,000 units = ` 5 Opportunity cost ` 5 are computed on the basis that the Division X will sacrifice ` 5 if they sell the product to Division Y.B. In this situation, the transfer price will be worked out as under: Transfer price = Marginal Cost + Contribution + Profit foregone by Division Z = ` (5 + 5 + 4) = ` 14 In situation (B), if Division Y purchases from Division X, it will not purchase from external supplier. Hence, the supplier will stop purchasing from Division Z, which will result in a loss of profit to Division Z @ ` 4 per unit, and therefore this amount will be recovered from the transfer price.Illustration 14:A company fixes the inter-divisional transfer prices for its products on thebasis of cost plus an estimated return on investment in its divisions. Therelevant portion of the budget for the Division X for the year 2015 -16 is givenbelow: Particulars Amount in (`) Fixed Assets 5,00,000 Current Assets (other than debtors) 3,00,000 Debtors 2,00,000 Annual fixed cost for the division 8,00,000 Variable cost per unit of product 10 Budgeted volume of production per year (units) 4,00,000 Desired Return on Investment 28%You are required to determine the transfer price for Division X.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL 43

MANAGEMENTSolution:

Computation of Transfer Price per unit for division X

Illustration 15:XYZ Ltd which has a system of assessment of Divisional Performance on thebasis of residual income has two Divisions, Alfa and Beta. Alfa has annualcapacity to manufacture 15,00,000 numbers of a special component that itsells to outside customers, but has idle capacity. The budgeted residual incomeof Beta is `1,20,00,000 while that of Alfa is `1,00,00,000. Other relevant detailsextracted from the budget of Alfa for the current years were as follows: Particulars 12,00,000 units @ ` 180 per Sale (outside customers) unit Variable cost per unit ` 160 Divisional fixed cost ` 80,00,000 Capital employed ` 7,50,00,000 Cost of Capital 12%

Beta has just received a special order for which it requires components similarto the ones made by Alfa. Fully aware of the idle capacity of Alfa, beta hasasked Alfa to quote for manufacture and supply of 3,00,000 numbers of thecomponents with a slight modification during final processing. Alfa and Betaagree that this will involve an extra variable cost of ` 5 per unit.

You are required to calculate,

The transfer price which Alfa should quote to Beta to achieve its budgetedresidual income.

Computation of transfer price when

(a) The capacity is 3800 hours:

The existing capacity is not sufficient to produce the units to meet the external sales. In order to transfer 300 units of Y, 1200 hours are required in which division A will give up the production of X to this extent. ` Variable cost of Y 24 ( contribution lost by giving up production of X to the extent of 1200 hours = 1200 x 5 = ` 6,000 ∴ Opportunity cost per unit = (6000/300) 20 Required transfer price 44

Illustration 18:Rana manufactures a product by a series of mixing of ingredients. The productis packed in company‘s made bottles and put into an attractive carton. Onedivision of company manufactures the bottles while another division preparesthe mix that does the packing.

The user division obtained the bottle from the bottle manufacturing division.The bottle manufacturing division has obtained the following quotations froman external source for supply of empty bottles.

Volume no of bottles For 8,00,000 bottles For 12,00,000 bottles

Total price offer (`) 14,00,000 20,00,000

The estimated cost is:

Volume no of bottles For 8,00,000 bottles For 12,00,000 bottles Total Cost (`) 10,40,000 14,40,000The sales value and the end cost in the mixing/packingdivision are: Volume no of bottles For 8,00,000 bottles For 12,00,000 bottles Total sales value (`) 91,20,000 1,27,80,000 Total Cost **(`) 10,40,000 96,80,000** Excluding cost ofbottles

There is a considerable discussion as to the proper transfer price from the

bottle division to the marketing division.

The divisional managers salary is an incentive bonus based on profits of the

centres.

You are required to show for the given two levels of activity the profitability ofthe two divisions and the total organisation based on appropriate transferprice determined on the basis of:(i) Shared profit related to the cost(ii) Market price

Illustration 19:PH Ltd. manufactures and sells two products, namely BXE and DXE. Thecompany‘s investment in fixed assets is `2 lakh. The working capitalinvestment is equivalent to three months‘ cost of sales of both the products.The fixed capital has been financed by term loan lending institutions at aninterest of 11% p.a. Half of the working capital is financed through bankborrowing carrying interest at the rate of 19.4%, the other half of the workingcapital being generated through internal resources.

The operating data anticipated for 2015-16 is as under:

Direct wage rate `2 per hour. Factory overheads are recovered at 50% of directwages. Administrative overheads are recovered at 40% of factory cost. Sellingand distribution expenses are `2 and `3 per unit respectively of BXE and DXE.The company expects to earn an after tax profit of 12% on capital employed.The income tax rate is 50%.Required:(i) Prepare a cost sheet showing the element wise cost, total cost profit and selling price per unit of both the products.(ii) Prepare a statement showing the net profit of the company after taxes for the 2013-14.

Illustration 2:Two businesses AB Ltd and CD Ltd sell the same type of product in the same market.Their budgeted profits and loss accounts for the year ending 30th June, 2016 are asfollows: AB Ltd (`) CD Ltd (`) Sales 1,50,000 1,50,000 Less: Variable costs 1,20,000 1,00,000 Fixed Cost 15,000 1,35,000 35,000 1,35,000 Profit 15,000 15,000You are required to calculate the B.E.P of each business and state which business is likelyto earn greater profits in conditions.(a) Heavy demand for the product(b) Low demand for the product.

From the above computation, it was found that the product produced by CD Ltd is moreprofitable in conditions of heavy demand because its P/V ratio is higher. On the otherhand, in the condition of low demand, the product produced by AB Ltd is more profitablebecause its BEP is low.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 51Illustration 3:A factory is currently working to 40% capacity and produces 10,000 units. At 50% theselling price falls by 3%. At 90% capacity the selling price falls by 5% accompanied bysimilar fall in prices of raw material. Estimate the profit of the company at 50% and 90%capacity production.The cost at present per unit is: ` Material 10 Labour 3 Overheads 5 (60% fixed)

From the above you are required to compute the following assuming that the fixed costremains the same in both periods.1. P/V Ratio2. Fixed cost3. The amount of profit or loss where sales are ` 6,48,0004. The amount of sales required to earn a profit of ` 1,08,000

Illustration 8:The following figures relate to a company manufacturing a varied range of products: Total Sales (`) Total Cost(`) Year ended 31-12-2014 22,23,000 19,83,600 Year ended 31-12-2015 24,51,000 21,43,200Assuming stability in prices, with variable cost carefully controlled to reflect pre-determined relation.(a) The profit volume ratio to reflect the rates of growth for profit and sales and(b) Any other cost figures to be deduced from the data.

Illustration 9:SV Ltd a multi product company furnishes you the following data relating to the year2015: First Half of the year (`) Second Half of the year (`) Sales 45,000 50,000 Total cost 40,000 43,000

Assuming that there is no change in prices and variable cost and that the fixed expensesare incurred equally in the two half year period, calculate for the year, 2015(i) The P/V Ratio,(ii) Fixed Expenses(iii) Break-even sales(iv) Percentage of Margin of safety.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 55Calculate:(1) The B.E.P and M/S for six months ending 30th June, 2015.(2) Expected sales volume for the second half of the year assuming that the P/V Ratio and Fixed expenses remain constant in the second half year also.(3) The B.E.P and M/S for the whole year for 2015.

You are required to compute the P/V ratio for each product and then compute the P/VRatio, Breakeven Point and net profit for the following assumption.(i) Sales revenue divided 60% to Product L & 40% to Product M.(ii) Sales revenue divided 40% to Product L & 60% to Product M.

Also calculate the profit estimated on sales upto `1,80,000/- p.m. for each of the salesmix provided above.

Solution:

Computation of P/V ratio

Particulars L M Total P/V ratio (C/S) x 100 30% 50% 40%

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 56(i) For Assumption I:

Statement showing computation of P/V ratio, Breakeven point and profit:

Break even sales = 14,700 / 31.8% = ` 46,226

Illustration 13:Present the following information to show to management:(i) The marginal product cost and the contribution p.u.(ii) The total contribution and profits resulting from each of the following sales mix results.

From the above computations, we may comment upon the profitability in the followingmanner.1. If total sales potential in units is limited, product B is more profitable, it has more contribution per unit.2. When total sales in value is limited, product B is more profitable because it has higher P/V ratio.3. If the raw material is in short supply, Product A is more profitable because it has more contribution per Kg of material.4. If the production capacity is limited, product B is more profitable, because it has more contribution per machine hour.

* Fixed cost is taken at maximum capacity (3,500 x 10)

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 60Illustration 15:A company has a capacity of producing 1 lakh units of a certain product in a month. Thesales department reports that the following schedule of sales prices is possible.

VOLUME OF PRODUCTION SELLING PRICE PER UNIT

% (`) 60 0.90 70 0.80 80 0.75 90 0.67 100 0.61

The variable cost of manufacture between these levels is 15 paise per unit and fixed cost` 40,000. Prepare a statement showing incremental revenue and differential cost at eachstage. At which volume of production will the profit be maximum?

The capacity of the plant is 1 lakh units. A customer from U.S.A. is desirous of buying20,000 units at a net price of ` 10 per unit. Advice the producer whether or not offershould be accepted. Will your advice be different, if the customer is local one.

As the profit is increased by ` 20,000 by accepting the order, it is advised to accept thesame. If the order is from local one, it should not be accepted because it will adverselyaffect the present market.

Illustration 17:A company manufactures scooters and sells it at `3,000 each. An increase of 17% in costof materials and of 20% of labour cost is anticipated. The increased cost in relation to thepresent sales price would cause at 25% decrease in the amount of the present grossprofit per unit.At present, material cost is 50%, wages 20% and overhead is 30% of cost of sales.You are required to:(a) Prepare a statement of profit and loss per unit at present and;(b) Compute the new selling price to produce the same percentage of profit to cost of sales as before.

From the above computations, it was found that profit is decreased by ` 19,600 by closingdown division ‗C‘, it should not be closed down. In other words, as long as if there is acontribution of ` 1, from division ‗C‘, it should not be closed down.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 64Illustration 20:Mr. Young has ` 1,50,000 investment in a business. He wants a 15% profit on his money.From an analysis of recent cost figures he finds that his variable cost of operating is 60%of sales; his fixed costs are `75,000 per year. Show supporting computations for eachanswer.a) What sales volume must be obtained to break-even?b) What sales volume must be obtained to his 15% return on investment?c) Mr. Young estimates that even if he closed the doors of his business he would incur `25,000 expenses per year. At what sales would be better off by locking his sales up?

The company is thinking of expanding the plant. The increased fixed cost with plantexpansion will be `40,000. It is estimated that the maximum production in new plant willbe worth `2,40,000. The company also wants to earn additional income `3,200 oninvestment. On the basis of computations give your opinion on plant expansion.

Solution:

Statement showing computation of profit before and after plant expansion:

From the above computations, it was found that the profit is increased by ` 22,400 byexpanding the plant, which is much higher than the expected income of ` 3,200, one‘sopinion should be in favour of plant expansion.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 65Illustration 22:A manufacturer with overall (interchangeable among the products) capacity of 1,00,000machine hours has been so far producing a standard mix of 15,000 units of product A,10,000 units of product B and C each. On experience, the total expenditure exclusive ofhis fixed charges is found to be ` 2.09 lakhs and the cost ratio among the productapproximately 1, 1.5, 1.75 respectively per unit. The fixed charges comes to ` 2 per unit.When the unit selling prices are ` 6.25 for A, ` 7.5 for B and `10.5 for C. He incurs a loss.

As management accountant, one should recommend Mix III because there is profit of `300 against loss at other mixes including present mix.

Illustration 23:A Co. has annual fixed costs of ` 1,40,000. In 2015 sales amounted to `6,00,000, ascompared with ` 4,50,000 in 2014, and profit in 2015 was ` 42,000 higher than that in2014.(i) At what level of sales does the company break-even?(ii) Determine profit or loss on a forecast sales volume of ` 8,00,000(iii)If there is a reduction in selling price by 10% in 2016 and the company desires to earn the same amount of profit as in 2015, what would be the required sales volume?

An export order has been received that would utilise half the capacity of the factory. Theorder has either to be taken in full and executed at 10% below the normal domesticprices, or rejected totally.The alternatives available to the management are given below:a) Reject order and Continue with the domestic sales only, as at present;b) Accept order, split capacity equally between overseas and domestic sales and turn away excess domestic demand;c) Increase capacity so as to accept the export order and maintain the present domestic sales by: i) buying an equipment that will increase capacity by 10% and fixed cost by `40,000 and ii) Work overtime a time and a half to meet balance of required capacity.Prepare comparative statements of profitability and suggest the best alternative.

Solution:

Statement showing computation of profit at present and at proposed two

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 68As the profit is more at the Alternative III, i.e. accepting foreign order fully andmaintaining present domestic sales fully, it is the best alternative to be suggested. 20%Overtime cost = (80,000 × 80% ) = ` 20,000.

Illustration 25:A Company has just been incorporated and plan to produce a product that will sell for `10 per unit. Preliminary market surveys show that demand will be around 10,000 unitsper year.

The company has the choice of buying one of the two machines ‗A‘ would have fixedcosts of ` 30,000 per year and would yield a profit of ` 30,000 per year on the sale of10,000 units. Machine `B‘ would have fixed costs `18,000 per year and would yield aprofit of ` 22,000 per year on the sale of 10,000 units. Variable costs behave linearly forboth machines.Required to:a) Break-even sales for each machineb) Sales level where both machines are equally profitablec) Range of sales where one machine is more profitable than the other.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL 69

MANAGEMENTIllustration 26:A practicing Cost Accountant now spends ` 0.90 per k.m. on taxi fares for his client‘swork. He is considering to other alternatives the purchase of a new small car or an oldbigger car.

He estimates that he does 10,000 K.m. annually. Which of the three alternatives will becheaper? If his practice expands he has to do 19,000 Km p.a. which is cheaper? Will costof the two cars break even and why? Ignore interest and Income-tax.

Solution:

Statement showing computation of comparative cost of three alternatives

(i) At 10,000 kms, old bigger car is cheaper.

The distance at which cost of two cars is equal is = (5,900 – 3,500) / (0.5 – 0.35) =16,000 Kms Indifference point for firm‘s old bigger car and taxi = 3500 / 0.4 = 8,750 kmsIndifference point for firm‘s new small car and taxi = 5,900 / 0.55 = 10,727 kms

Illustration 27:There are two plants manufacturing the same products under one corporatemanagement which decides to merge them.

PLANT - I PLANT - II Capacity operation 100% 60% Sales (`) 6,00,00,000 2,40,00,000 Variable costs (`) 4,40,00,000 1,80,00,000 Fixed Costs (`) 80,00,000 40,00,000COST & MANAGEMENT ACCOUNTING AND FINANCIALMANAGEMENT 70You are required to calculated for the consideration of the Board of Directorsa) What would be the capacity of the merged plant to be operated for the purpose of break-even?b) What would be the profitability on working at 75% of the merged capacity.

Solution:

Statement showing computation of Breakeven of merged plant and other required

It has been decided to merge plant B with Plant A. The additional fixed expenses involvedin the merger amount to is ` 2 lakhs.Required:1) Find the break-even-point of plant A and plant B before merger and the break-even point of the merged plant.2) Find the capacity utilisationsation of the integrated plant required to earn a profit of ` 18 lakhs.

Illustration 29:A company engaged in plantation activities has 200 hectors of virgin land which can beused for growing jointly or individually tea, coffee and cardamom, the yield per hector ofthe different crops and their selling prices per Kg. are as under:

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT 73

The fixed costs in each season would be: Cultivation & Growing `56,000: Picking `42,000 Transport - `10,000: Administration-`84,000 Land Revenue - `18,000The following limitations are also placed before you:a) The area available is 450 acres, but out of this 300 acres are suitable for growing only Oranges and Lemons .The balance of 150 acres is suitable for growing for any of the four fruits viz., Apples, Lemons, Oranges and Peaches.b) As the products may be hypothecated to banks, area allotted for any fruit should be demarcated in complete acres and not in fractions of an acre.c) The marketing strategy of the company requires the compulsory production of all the four types of fruits in a season and the minimum quantity of any type to be 18,000 boxes.

Calculate the total profits that would accrue if your advice is accepted.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 74Illustration 31:A market gardener is planning his production for next season and he asked you, as a costconsultant, to recommend the optimum mix of vegetable production for the coming year.He has given you the following data relating to the current year: POTATOES TOMATOES PEAS CARROTS Area occupied in acres 25 20 30 25 Yield per acre in tons 10 8 90 12 Selling Price per ton (`) 1,000 1,250 1,500 1,350 Variable Cost per acre: Fertilizer 300 250 450 400 Seeds 150 200 300 250 Pesticides 250 150 200 250 Direct Wages 4,000 4,500 5,000 5,700

Fixed Overhead per annum: `5,40,000

The land which is being used for the production of carrots and peas can be used foreither crop but not for potatoes and tomatoes. The land being used for potatoes andtomatoes can be used for either crops but not carrots and peas. In order to provide anadequate market service, the gardener must produce each year at least 40 tons of eachof potatoes and tomatoes and 36 tons of each peas and carrots .You are required topresent a statement to show :(a) (1) The profit for the current year: (2) The profit for the production mix you would recommend;(b) Assuming that the land could be cultivated in such a way that any of the above crops could be produced and there was no market commitment. You are required to: (1) Advice the market gardener on which crop he should concentrate his production. (2) Calculate the profit if he were to do so, and (3) Calculate in rupees the breakeven - point of sales.

Solution:

Statement showing computation of contribution and determination of priority for

(b) (1) If the land is suitable for growing any of the crops and there is no market commitment, the gardener is advised to concentrate his production on carrots.(2) & (3): Sl. No. Particulars ` I Sales (16,200 x 100) 16,20,000 II Contribution (9,600 x 100) 9,60,000 III Fixed cost 5,40,000 IV Profit 4,20,000Break even sales = (5,40,000 x 16,20,000) /9,60,000 = ` 9,11,250Illustration 32:Small Tools Factory has a plant capacity adequate to provide 19,800 hours of machineuse. The plant can produce all A type tools or all B type tools or a mixture of these twotype. The following information is relevant A B Selling price (`) 10 15 Variable cost (`) 8 12 Hours required to produce 3 4

Market conditions are such that not more than 4,000 A type tools and 3,000 B type toolscan be sold in a year. Annual fixed costs are ` 9,900.Compute the product mix that will maximise the net income to the company and findthat maximum net income.

The processing hour cannot be increased beyond 200 hrs per month.You are required to:(a) Compute the most profitable product-mix.(b) Compute the overall break-even sales of the co., for the month based in the mix calculated in (a) above.

Solution:

(a) Statement showing computation of contribution per hour and determination

Illustration 34:A factory budget for a production of 1,50,000 units. The variable cost per unit is ` 14 andfixed cost is ` 2 per unit. The company fixes its selling price to fetch a profit of 15% oncost.(a) What is the breakeven point?(b) What is the profit volume ratio?(c) If it reduces its selling price by 5% how does the revised selling price affect the BEP and the profit volume ratio?(d) If a profit increase of 10% is desired more than the budget what should be the sale at the reduced prices?

The expenses - fixed are estimated at `6,80,000. The company uses a single raw materialin all the three products. Raw material is in short supply and the company has a quota forthe supply of raw materials of the value of ` 18,00,000 for the year 2011-12 for themanufacture of its products to meet its sales demand.

You are required to:-

a. Set a product mix which will give a maximum overall profit keeping the short supply of raw material in view.b. Compute that maximum profit.

Solution:

Statement showing computation of contribution per rupee of material and

Sales in units 10,000

The finance Manager who feels perturbed suggests that the company should at leastbreak-even in the second quarter with a drive for increased sales. Towards this thecompany should introduce a better packing which will increase the cost by ` 0.50 perunit.The Sales Manager has an alternate proposal. For the second quarter additional salespromotion expenses can be increased to the extent of ` 5,000 and a profit of `5,000 canbe aimed at for the period with increased sales.The production manager feels otherwise. To improve the; demand the selling price perunit has to be reduced by 3%. As a result the sales volume can be increased to attain aprofit level of ` 4,000 for the quarter.The Managing Director asks for as a Cost Accountant to evaluate these three proposalsand calculate the additional units required to reach their respective targets help him tomake a decision.

Calculate:(i) the no. of units which must be sold to break even in each of the two years(ii) the no. of units which would have to be sold to double the profit of the base year under base year conditions(iii) the no. of units which will have to be sold in the budget year to maintain the profit level of preceding year.

Factory overheads are absorbed on the basis of machine hour which is the limiting factor.The machine hour rate is `2 per hour. The company receives an offer from Canada for thepurchase of Product A at a price of `17.50 per unit.Alternatively the company has another offer from the Middle East for the purchase ofProduct B at a price of `15.50 p.u.In both cases, a special packing charge of fifty paise per unit has to be borne by thecompany.The company can accept either of the two export orders and in the either case thecompany can supply such quantities as may be possible to produce by utilising thebalance of 25% of its capacity.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL 83

MANAGEMENTYou are required to prepare:(1) A statement showing the economics of the two export proposals giving your recommendation as to which the proposal should be accepted, and(2) A statement showing the overall profitability of the company after incorporating the export proposal recommended by you.

Illustration 40:Your company has a production capacity of 2,00,000 units per year. Normal capacityutilisation is reckoned at 90%. Standard Variable Production costs are ` 11p.u. The fixedcosts are ` 3,60,000 per year. Variable selling costs are ` 3p.u. and fixed selling costs are`2,70,000 per year. The unit selling price is `20. In the year just ended on 30th June,2012, the production was 1,60,000 units and sales were 1,50,000 units. The closinginventory on 30-6-2012 was 20,000 units. The actual variable production costs for theyear was ` 35,000 higher than the standard.COST & MANAGEMENT ACCOUNTING AND FINANCIALMANAGEMENT 84Calculate:(1) The profit for the year (a) by absorption costing method (b) by the marginal cost method.(2) Explain the difference in profits.

The difference in profits can be explained as follows:

Illustration 41:From the following data calculate:(1) B.E.P expressed in amount of sales in rupees.(2) Number of units that must be sold to earn a profit of `60,000 per year(3) How many units must be sold to earn a net income of 10% of sales.Sales price ` 20 per unit; variable manufacturing costs ` 11 p.u.; fixed factory overheads `5,40,000 p.a.; variable selling costs ` 3 p.u. Fixed selling costs ` 2,52,000 per year.

Illustration 42:The Board of Directors of KE Ltd. manufacturers of three products A, B and C have askedfor advice on the production mixture of the company.(a) You are required to present a statement to advice the directors of the most profitable mixture of the products to be made and sold. The statement should show: i) The profit expected on the current budgeted production, and ii) The profit which could be expected if the most profitable mixture was produced.

(b) You are also required to direct the director‘s attention to any problem which is likely to arise if the mixture in (a) (ii) above were to be produced.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 86 The following information is given:- Data for standard Costs, per unit:

The manufacture of these products will necessitate the provision of special toolingcosting approximately ` 4,500. The price per unit is ` 8.00. For an order to be consideredprofitable it is necessary for it to yield a target contribution at the rate of ` 0.30 perLabour Hour (after tooling cost).

Find out:a. The sales level at which contribution to profit commences.b. The sales at which the contribution exceeds the target.Solution:

The board of directors plan to introduce more mechanisation into the department at acapital cost of ` 40,000. The effect of this will be to reduce the number of employees to120, but to increase the output per individual employees by 40%. To provide thenecessary incentive to achieve the increased output, the board intends to offer a 1%increase on the piece of work price of 25 paise per article for every 2% increase inaverage individual output achieved. To sell the increased output, it will be necessary todecrease the selling price by 4%. Calculate the extra weekly contribution resulting fromthe proposed change and evaluate for the board‘s consideration, the worth of the project.

From the above computation, it was found that there is no extra contribution due toincrease of mechanization and in fact contribution decreased by ` 5,820. There is noworth of project.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 89Self Learning Questions:

1. Distinguish between Marginal Costing and Absorption costing.

2. Discuss the importance of the following a. Key factor b. Breakeven point c. Margin of safety3. State the utility of marginal costing in price fixation during trade depression and for export purposes.4. Define marginal costing and state the features of marginal costing5. State the benefits accrue out of application of Marginal Costing6. Discuss the overcomes of Marginal costing in brief.7. What do you mean by Transfer pricing. State the objects in brief.8. Explain the various methods of Transfer pricing9. State the objective of Inter Company Transfer Pricing10. What do you mean by Differential Cost Analysis. State its silent features.

Multiple Choice Questions:

1. The breakeven point is the point at which,

A. There is no profit, no loss B. Contribution margin is equal to total fixed cost C. Total fixed cost is equal to total revenue D. All of the above.2. A large margin of safety indicates A. Over capitalization B. The soundness of business C. Overproduction D. None of the above3. The selling price is `20 per unit, variable cost `12 per unit, and fixed cost `16,000, the breakeven-point in units will be A. 800 units B. 2000 units C. 3000 units D. None of these4. The P/V ratio of a product is 0.4 and the selling price is `40 per unit. The marginal cost of the product would be, A. `8 B. `24 C. `20 D. `255. Fixed cost per unit decreases when, A. Production volume increases B. Production volume decreases C. Variable cost per unit decreases D. Variable cost per unit increases.6. Each of the following would affect the breakeven point except a change in the, A. Number of units sold.

State the following statement is true or false:

1. Marginal cost includes prime cost plus fixed overheads.

2. Contribution is the difference between the selling price and the total costs.3. An increase in the volume of the production will result in reduction in unit variable cost.4. The amount of profit under absorption costing and marginal costing is one and the same.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 915. All variable costs are included in the marginal cost.6. Margin of safety is the difference between actual sales and the sales and the break even point.7. The difference between the budgeted output and the actual output is known as margin of safety.8. The breakeven point will be lower if the selling price is increased but the amount of cost does not change.9. At breakeven point margin of safety is nil.10. When fixed cost is deducted from total cost, we get marginal cost.

Fill in the blanks:

1. In cost accounting, marginal cost does not include .

2. In absorption costing, ____________ cost is added to inventory.3. Sales minus variable cost = fixed costs plus ____________ .4. Profit volume ratio is contribution / ______________ X 1005. At breakeven point total revenue is equal to costs.6. In marginal costing, fixed costs are charged to ____ __________.7. Margin of safety is the difference between ____ and ________________ .8. In marginal costing, stock is valued at ___________.9. When the production volume is nil, the loss will be equal to_________.10. Constraint on various resources is also known as _____________ .

THIS STUDY NOTE INCLUDES:

3.1 BUDGETARY CONTROL AND PREPARATION OF FUNCTIONAL AND MASTER

BUDGETING

BUDGETARY CONTROL

Budgetary control is defined as ―the establishment of budgets relating the

responsibilities of executives to the requirements of a policy and the continuouscomparison of actual with budgeted results, either to secure by individual action theobjective of that policy or to provide a basis for its revision.‖

From the above definition, the steps for Budgetary Control can be drawn asfollows: - (i) Establishment of Budgets:Budgetary control primarily aims at preparation of various budgets such as sales Budget,production budget, overhead expenses budget, cash budget etc.,(ii) Responsibilities of executives:The budgetary control system is designed to fix responsibilities on executivesthroughpreparation of budgets.(iii) Policy making:The established policies of the organisation are designed as budgets so as to fixresponsibility on executives.(iv) Comparison of actuals with budgets:After establishing the budgets, the actuals are compared with them and any deviations, ifany are called variances.(v) Achieving the desired result:The desired result of the budgetary control system is comparison of actuals with thebudgeted results and the causes of variances, if any, are analysed.(vi) Reporting to Top Management:After the causes of Variances are analysed, the variances and their causes are reportedto top management so that the remedial action can be taken.

Advantages of Budgetary Control:

(i) Budgetary control aims at maximisation of profits through optimum utilisation of resources.(ii) It is a technique for continuous monitoring of policies and objectives of the organisation.(iii) It helps in reducing the costs, thereby helps in better utilisation of funds of the organisation.(iv) All the departments of the organisation are closely coordinated through establishment of plans resulting in smooth functioning of the organisation.(v) Since budgets fix the responsibilities of the executives, they act as a plan of action for them there by reducing some of their work.

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MANAGEMENT (vi) It facilitates analysis of variances, thereby identifying the areas where deficiencies occur and proper remedial action can be taken. (vii) It facilitates the management by exception. (viii) Budgets act as a motivating force to achieve the desired objective of the organisation. (ix) It assists delegation of authority and is a powerful tool of responsibility accounting. (x) It helps in stabilizing the conditions in industries which face seasonal fluctuations. (xi) It helps as a basis for internal audit. (xii) It provides a suitable basis for introducing the payment by results system. (xiii) It ensures adequacy of working capital to the organisation. (xiv) It aids in performance analysis and performance reporting system. (xv) It aids in obtaining bank credit. (xvi)Budgets are forerunners of standard costs in the sense that they create necessary conditions to suit setting up of standard costs.

Preliminaries for the Adoption of a System of Budgetary Control:

For the successful implementation of a system of budgetary control certain pre-requisites are to be fulfilled. These are enumerated below: (i) There should be an organization chart laying out in clear terms the responsibilities and duties of each level of executives, and the delegation of authority to the various levels. For complete success, a solid foundation in this regard should be laid at the outset. (ii) The objectives, plans and policies of the business should be defined in clear cut and unambiguous terms. (iii) The output level for which budgets are fixed, i.e., the budgeted output, should be stated. (iv) The particular budget factor which will be the starting point of the preparation of the various budgets should be indicated. (v) There should be an efficient system of accounting to record and provide data in line with the budgetary control system. (vi) For the establishment and efficient execution of the plan, a Budget Committee should be set up. (vii) There should be a proper system of communication and reporting between the various levels of management. (viii)There should be a charter of programme. This is usually in the form of a budget manual. (ix) The budgets should primarily be prepared by those who are responsible for performance. (x) The budgets should be complete, continuous and realistic. (xi) There should be an assurance from the top management executives of co-operation and acceptance of the budgetary system.

Functional Budget: If budgets are prepared of a business concern for a certain period taking each and every function separately such budgets are called functional budgets. Example: Production, Sales, purchases, cost of production, cash, materials etc.

The following are the various functional budgets, some of which are briefly explained here under:(i) Sales Budget: The sales budget is a forecast of total sales, expressed in terms of money or quantity or both. The first step in the preparation of the sales budget is to forecast as accurately as possible, the sales anticipated during the budget period. Sales forecasts are usually prepared by the sales manager assisted by the market research personnel.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 94 Factors to be considered in preparing Sales Budget:- As business existence depends upon the sales it is going to make and therefore it is an important one to be prepared meticulously. It is the forecast of what it can reasonably sell to its customers during the period for which budget is prepared. The company‘s profit mostly depends upon the ability to sell its products to customers. In the present era it is indispensable to establish the demand for the product even before it is produced. It is the sales order book that the company‘s continuity depends upon. Also, a reasonable degree of accuracy must be there in preparing a sales budget unless its sales are accurately forecast, production estimates will also become erroneous. A good amount of experience must be necessary to prepare the sales budget. Yet the following factors must be considered in preparing the sales budget: (a) The locality of the market i.e., domestic or export (b) The target customers i.e., industry or trade or a section or group of general public etc., (c) The product portfolio i.e., the number of products offered and their popularity among the target customers. (d) The market share of each product and its influence on the product portfolio and the total market (e) The effectiveness of existing marketing policy on the current sales volume and value. (f) The market share of competitor‘s products and their effect on the company‘s sales. (g) Seasonal fluctuation in sales. (h) Expenditure on advertisement and its impact on sales.

(ii) Production Budget: The production budget is a forecast of the production for the budget period. Production budget is prepared in two parts, viz. production volume budget for the physical units of the products to be manufactured and the cost of production or manufacturing budget detailing the budgeted cost under material, labour, and factory overhead in respect of the products.

Factors to be considered in Production Budget:

Next to the sales budget, the main function of a business concern is the production and for this, a budget is prepared simultaneously with the sales budget. It is the forecast of production during the period for which the budget is prepared. It can also be prepared in two parts viz., production volume budget for the physical units i.e., the number of units, the tonnes of production etc., and the cost of production or manufacture showing details of all elements of the manufacture. While preparing the production budget, the following factors must be taken into consideration:-

(a) Production plan:-

Production planning is an important part of the preparation of the production budget. Optimum utilisation of plant capacity is taken by eliminating or reducing the limiting factors and thereby effective production planning is made.

(a) The capacity of the business concern:-

It is to be ensured that the capacity of the organisation will coincide the budgeted production or not. For this purpose, plant utilisation budget will also be necessary. The production budget must be based on normal capacity likely to be achieved and it should not be too high or too low.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 95(c) Inventory Policy:- While preparing the production budget it is also necessary to see to what extent materials are available for producing the budgeted production. For that purpose, a purchase budget or a purchase plan must also be studied. Similarly, on the other hand, it is also necessary to verify the extent to which the inventory of finished goods is to be carried.(d) Sales budgets must also be considered before preparing production budget because it may so happen that the entire production of the concern may not be sold. In such a case the production budget must be in line with the sales budget.(e) A plan of the sequence of operations of production for effective preparation of a production budget should always be there.(f) Last, but not the least, the policy of the management should also be considered before preparing the production budget.Objectives and Advantages of Production budget: Optimum utilisation of the productive resources of the organisation; Maintaining low inventory which results in risk of deterioration and fall in prices; Focus on the factors that are necessary to frame policies and plan sequence of operations; Projection of policies framed, on the basis of past performance, into the future to get the desired results; To see that right materials are provided at right place and at right time; Helps in scheduling of production so that delivery dates are met and customer satisfaction is gained; Helpful in preparation of projected profit and loss statement, which is useful in evaluation of performance and profitability.(iii) Materials Budget: The material budget includes quantities of direct materials; the quantities of each raw material needed for each finished product in the budget period is specified. The input data for this budget is obtained by applying standard material usage rates by each type of material to the volume of output budgeted.(iv) Purchase Budget: The purchase budget establishes the quantity and value of the various items of materials to be purchased for delivery at specified points of time during the budget period taking into account the production schedule of the concern and the inventory requirements. It takes into account the requirements for the entire budget plan as per the sales, materials, maintenance, research and development, and capital budgets. Purchases may be required to be made in respect of direct and indirect materials, finished goods for resale, components and parts, and purchased services. Before incorporation in the purchase budget, these purchase requirements should be suitably ascertained. Purchase budget also includes material procurement budget.(v) Cash Budget: Cash Budget is estimated receipts and expenses for a definite period, which usually are cash sales, collection from debtors and other receipts and expenses and payment to suppliers, payment of wages, payment of other expenses etc.(vi) Direct Labour Budget.(vii)Human Resources Budget.(viii)Selling and distribution cost budget.(ix) Administration Cost Budget.(x) Research and development Cost Budget etc.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 96Master Budget: Master budget is the budget prepared to cover all the functions of thebusiness organisation. It can be taken as the integrated budget of business concern, thatmeans, it shows the profit or loss and financial position of the business concern such asBudgeted Profit and Loss Account, Budgeted Balance Sheet etc. Master budget, alsoknown as summary budget or finalized profit plan, combines all the budgets for a periodinto one harmonious unit and thus, it shows the overall budget plan. The master budgetincorporates all the subsidiary functional budgets and the budgeted Profit and LossAccount and Balance Sheet. Before the budget plan is put into operation, the masterbudget is considered by the top management and revised if the position of profitdisclosed therein is not found to be satisfactory. After suitable revision is made, themaster budget is finally approved and put into action. Another view regards thebudgeted Profit and Loss Account and the Balance Sheet as the master budget.

3.2 FIXED, VARIABLE, SEMI-VARIABLE BUDGETS

Fixed or Rigid Budget:

When budgets are prepared for a fixed or standard volume of activity, they are calledstatic or rigid or fixed budgets. They do not change with the changes in the volume of theoutput. These are prepared normally 3 months in advance of the year. However these willnot be much helpful in comparing the actual activity, as these are prepared at a fixedvolume of output. It, however, does not mean that the fixed budget is a rigid one, not tobe changed at all. Though not adjusted to the actual volume attained, a fixed budget isliable to revision if due to business conditions undergoing a basic change or due to otherreasons, actual operations differ widely from those planned in the fixed budget.

Fixed budgets are most suited for fixed expenses. In case of discretionary costs situationswhere the expenditure is optional and has no relation with the output, e.g. expenditureon research and development, advertising, and new projects. A fixed budget has only alimited application and is ineffective as a tool for cost control. Fixed budgets are usefulwhere the plan permits maximum stabilization of production, as for example, forconcerns which manufacture to build up inventories of finished products andcomponents.Flexible Budget:A flexible budget is a budget that is prepared for different levels of activity or capacityutilization or volume of output. If the budgets are prepared in such a way so as to changein accordance with the volume of output, they are called flexible budgets. These can beprepared from fixed budget which are also called revised budgets. These are muchhelpful in comparison with actual because the exact deviations are found for which timelycorrective action can be taken. The basic idea of a flexible budget is that there shall besome standard of cost and expenditures. Thus, a budget prepared in a manner to givebudgeted costs for any level of activity is known as flexible budget. Such budget isprepared after considering the variable and fixed elements of costs and the changes,which may be expected for each item at various levels of operations. Thus a flexiblebudget recognises the difference in behaviour between fixed and variable costs inrelation to fluctuations in production or sales and is designed to change appropriatelywith such fluctuations. In flexible budget, data relating to costs, expenditures mayprogressively be changed in any month in accordance with actual output achieved. Whilepreparing flexible budgets, estimates of costs and expenditures on the basis of standardsdetermined are made from minimum to maximum level of operations.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 97Difference between Fixed and Flexible Budgets: Fixed Flexible Budget Budget (i) It does not change with actual volume of It can be recasted on the basis of activity activity achieved. Thus it is known as rigid level to be achieved. Thus it is not or rigid. inflexible budget. It operates on one level of activity(ii) and It consists of various budgets for different under one set of conditions. It assumes levels of that activity. there will be no change in the prevailing conditions, which is unrealistic. Here analysis(iii) Here as all costs like – fixed, variable and of variance provides useful semi-variable are related to only one level information as each cost is analysed of activity so variance analysis does notaccording to its behaviour. give useful information.(iv) If the budgeted and actual activity levels Flexible budgeting at different levels of differ significantly, then the aspects like cost activity facilitates the ascertainment of ascertainment and price fixation do notcost, fixation of selling price and tendering give a correct picture. of quotations.(v) Comparison of actual performance withIt provides a meaningful basis of target budgeted s will be meaninglesscomparison of the actual performance specially when there is a difference with the budgeted targets. between the two activity levels.

Principal Budget Factor:

Budgets cover all the functional areas of the organisation. For the effectiveimplementation of the budgetary system, all the functional areas are to be consideredwhich are interlinked. Because of these interlinks, certain factors have the ability toaffect all other budgets. Such factor is known as principle budget factor.

Principal Budget factor is the factor the extent of influence of which must first beassessed in order to ensure that the functional budgets are reasonably capable offulfilment. A principal budget factor may be lack of demand, scarcity of raw material,non-availability of skilled labour, inadequate working capital etc. If for example, theorganisation has the capacity to produce 2500 units per annum. But the productiondepartment is able to produce only 1800 units due to non-availability of raw materials. Inthis case, non-availability of raw materials is the principal budget factor (limiting factor).If the sales manger estimates that he can sell only 1500 units due to lack of demand.Then lack of demand is the principal budget factor. This concept is also known as keyfactor, or governing factor. This factor highlights the constraints with in which theorganisation functions.

Responsibility Accounting:One of the recent developments in the field of management accounting is theresponsibility accounting, which is helpful in exercising cost control. ‗ResponsibilityAccounting is a system of accounting that recognizes various responsibility centersthroughout the organization and reflects the plans and actions of each of these centersby assigning particular revenues and costs to the one having the pertinent responsibility.It is also called profitability accounting and activity accounting.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 98It is a system in which the person holding the supervisory posts as president, functionhead, foreman, etc are given a report showing the performance of the company ordepartment or section as the case may be. The report will show the data relating tooperational results of the area and the items of which he is responsible for control.Responsibility accounting follows the basic principles of any system of cost control likebudgetary control and standard costing. It differs only in the sense that it lays emphasison human beings and fixes responsibilities for individuals. It is based on the belief thatcontrol can be exercised by human beings, so responsibilities should be fixed forindividuals.

Principles of responsibility accounting are as follows:

(a) A target is fixed for each department or responsibility center.(b) Actual performance is compared with the target.(c) The variances from plan are analysed so as to fix the responsibility.(d) Corrective action is taken by higher management and is communicated.

Performance Budgeting:Performance Budgeting is synonymous with Responsibility Accounting which means thusthe responsibility of various levels of management is predetermined in terms of output orresult keeping in view the authority vested with them. The main concepts of such asystem are enumerated below:(a) It is based on a classification of managerial level for the purpose of establishing a budget for each level. The individual in charge of that level should be made responsible and held accountable for its performance over a given period of time.(b) The starting point of the performance budgeting system rests with the organisation chart in which the spheres of jurisdiction have been determined. Authority leads to the responsibility for certain costs and expenses which are forecast or present in the budget with the knowledge of the manager concerned.(c) The costs in each individual‘s or department‘s budget should be limited to the cost controllable by him.(d) The person concerned should have the authority to bear the responsibility.

3.3 Zero Based Budgeting (ZBB)

It differs from the conventional system of budgeting mainly it starts from scratch or zeroand not on the basis of trends or historical levels of expenditure. In the customarybudgeting system, the last year‘s figures are accepted as they are, or cut back orincreases are granted. Zero based budgeting on the other hand, starts with the premisethat the budget for next period is zero so long the demand for a function, process, projector activity is not justified for each rupee from the first rupee spent. The assumptions arethat without such a justification no spending will be allowed. The burden of proof thusshifts to each manager to justify why the money should be spent at all and to indicatewhat would happen if the proposed activity is not carried out and no money is spent.

The first step in the process of zero base budgeting is to develop an operational plan ordecision package. A decision package identifies and describes a particular activity with aview to:(i) Evaluate and allotted ranking the activity against other activities competing for the same scarce resources, and

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 99(ii) Decide whether to accept or reject or amend the activity.

For this purpose, each package should give details of costs, returns, purpose, expectedresults, the alternatives available and a statement of the consequences if the activity isreduced or not performed at all.

The advantages of Zero based budgeting are:

(a) Out of date and inefficient operations are identified.(b) Allows managers to promptly respond to changes in the business environment.(c) Instead of accepting the current practice, it creates a challenging and questioning attitude.(d) Allocation of resources is made according to needs and the benefits derived.(e) It has a psychological impact on all levels of management which makes each manager to ‗pay his way‘.

Areas where zero-base budgeting is applicable

Zero-base Budgeting is more suitably applicable to discretionary cost areas. These costsmay have no relation to volume or activity and generally arise as a result of managementpolicies. Where standards are determinable, those costs associated with the inputsshould be controlled through the use of standard costing. On the other hand, if output asa function of input cannot be specified. Zero-base Budgeting may be more suitablyapplied. Thus, service or support-type activities are more suitable for Z.B.B.

PROCESS OF ZERO-BASE BUDGETING OR STEPS INVOLVED IN ZERO-

BASE BUDGETING The process of Zero-Base Budgeting involves thefollowing steps:1. Identification of 'Decision units‘2. Preparation and development of decision packages.3. Ranking of priority.4. Approval and Funding

Identification of 'Decision units‘- A decision unit refers to a tangible activity or group

of activities for which a single manager has the responsibility for successful performance.Thus, decision unit is a programme or a project or a segment of the organisation forwhich separate budgets are to be prepared.

Preparation of Decision Packages: Preparation of decision packages is a set of

documents which identify and describe activities of the unit in such a way that themanagement can evaluate and rank them against others competing for resources(limited) and decide whether to approve or disapprove.

Ranking of Priority: The third step involved in Z.B.B. is the ranking of proposedalternatives included in decision packages for various decision units or of variousdecision packages for the same decision unit.

Funding: Funding involves the allocation of available resources of the organisation to

various decision units keeping in mind the alternative which has been selected andapproved through ranking process.

Cash balance on 1st January was `10,000. A new machinery is to be installed at `20,000on credit, to be repaid by two equal instalments in March and April, sales commission@5% on total sales is to be paid within a month following actual sales.

`10,000 being the amount of 2nd call may be received in March. Share premiumamounting to `2,000 is also obtained with the 2nd call. Period of credit allowed bysuppliers — 2months; period of credit allowed to customers — 1month, delay in paymentof overheads 1 month. delay in payment of wages ½ month. Assume cash sales to be50% of total sales.

(b) Credit terms are:

Sales/debtors: 10% sales are on cash, 50% of the credit sales are collected next monthandthe balance in the following month.Creditors: Materials 2 monthsWages 1/4 monthOverheads 1/2 month.(c) Cash and bank balance on 1st April, 2016 is expected to be ` 6,000.(d) other relevant information are: (i) Plant and machinery will be installed in February 2016 at a cost of `96,000. The monthly instalment of `2,000 is payable from April onwards. (ii) Dividend @ 5% on preference share capital of `2,00,000 will be paid on 1st June. (iii) Advance to be received for sale of vehicles `9,000 in June. (iv) Dividends from investments amounting to `1,000 are expected to be received in June.

The new sales manager who has joined the company recently estimates for the next yeara profit of about 23% on capital employed, provided the volume of sales is increased by10% and simultaneously there is an increase in selling price of 4% and an overall costreduction in all the elements of cost by 2%.

Find out by computing in detail the cost and profit for next year, whether the proposal ofsales manager can be adopted.

Illustration 10:Three Articles X, Y and Z are produced in a factory. They pass through two cost centers Aand B. From the data furnished compile a statement for budgeted machine utilization inboth the centers.

The monthly budgets for manufacturing overhead of a concern for two levels of activitywere as follows:Capacity 60% 100%Budgeted production (units) 600 1,000 ` `Wages 1,200 2,000Consumable stores 900 1,500Maintenance 1,100 1,500Power and fuel 1,600 2,000depreciation 4,000 4,000Insurance 1,000 1,000 9,800 12,000You are required to:(i) Indicate which of the items are fixed, variable and semi-variable;(ii) Prepare a budget for 80% capacity and(iii) Find the total cost, both fixed and variable per unit of output at 60%, 80% and 100%capacity.

Total Purchases = ` 24500+16400+20500+11000 = ` 72400.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 112Self Learning Questions:

1. What do you mean by Budgetary control? State its advantages.

2. Discuss the preliminaries for the adoption of a system of Budgetary Control.3. Discuss the factors to be considered on production budget.4. Distinguish between flexible budget and fixed budget.5. Write a short note as responsibility accounting and performance budgeting.6. Write a short note on ―Zero based budgeting‖.7. List down the steps involved in zero based budgeting.8. Explain the various types of budget.

Multiple Choice Questions:

1. Budget period depends upon…

A. The type of budget B. The nature of business C. The length of trade cycles D. All of these2. A key factor is one which restricts… A. The volume of production B. The volume of sales C. The volume of purchase D. All of the above3. Budget relating to the key factor is prepared… A. After other budgets B. With other budgets C. Before other budgets D. None4. The budgets are classified on the basis of… A. Time B. Function C. Flexibility D. All5. An example of long period budget is… A. R& D budget B. Master budget C. Sales budget D. Personnel budget6. Sales budget shows the sales details as… A. Month wise B. Product wise C. Area wise D. All of the above7. The main objective of budgetary control is… A. To define the goal of the firm B. To coordinate different departments C. To plan to achieve its goals D. All of the above

Match the following:

Column A Column B 1 A budget is a plan of action expressed in… A Definite period 2 A budget is tool which helps the management in planning B Management and control of… 3 Budgetary control system acts as a friend, philosopher and C Financial terms & guide to the… Non‐financial terms 4 Budget is prepared for a… D Decision making All business 5 Zero based Budgeting E activities[Ans: E,C,B,A,D]

State whether the following statement is True or False:

1. Zero Based Budgeting cannot be used for Decision making.

2. There is necessity to revise the budget.3. A budget is expressed in financial or Quantitative terms.4. A budget is prepared for a specified period.5. A flexible budget takes into account only fixed costs.6. The master budget is prepared first and all other budgets are sub ordinate to it7. The key factor should not be taken into account while preparing budgets.8. A budget is a summary of all functional budgets.9. A flexible budget is prepared for more than one level of activity.10. Cash budget shows the expected sources and utilisation of cash.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

114Fill in the Blanks:

1. Budgetary control system facilitates centralized control with ___________.

2. Budgetary control facilitates easy introduction of the ____________.3. Budgetary control helps the management in ______________.4. Budgetary control system helps the management to eliminate ________________________.5. Budgetary control provides a basis for ______________.6. Budgetary control helps to introduce a suitable incentive and remuneration based on __.7. Budgetary control __________ replace management in decision‐making.8. The success of budgetary control system depends upon the willing cooperation of ______.9. Recording of actual performance is __________________.10. Revision of budgets is ___________________.

THIS STUDY NOTE INCLUDES:

4.1 Introduction4.2 Computation of variances for each of the elements of costs, Sales Variances4.3 Investigation of variances – & Reporting of variances4.4 Valuation of Stock under Standard Costing4.5 Uniform Costing and Inter-firm comparison

4.1 INTRODUCTION

During the first stages of development of cost accounting, historical costing was the onlymethod available for ascertaining and presenting costs. Historical costs have, however,the following limitations:a) Historical cost is valid only for one accounting period, during which the particular manufacturing operation took place.b) Data is obtained too late for price quotations and production planning.c) Historical cost relating to one batch or lot of production is not a true guide for fixing price.d) Past actual are affected by the level of working efficiencies.e) Historical costing is comparatively expensive as it involves the maintenance of a large volume of records and forms.

The limitations and disadvantages attached to historical costing system led to furtherthinking on the subject and resulted in the emergence of standard costing which makesuse of scientifically predetermined standard costs under each element.

Definition:Standard Costing is defined as ―the preparation and use of standard cost, their comparisonwith actual costs and the measurement and analysis of variances to their causes andpoints of incidence.‖

General Principles of Standard Costing:

1. Predetermination of technical data related to production. i.e., details of materials and labour operations required for each product, the quantum of inevitable losses, efficiencies expected, level of activity, etc.2. Predetermination of standard costs in full details under each element of cost, viz., labour, material and overhead.3. Comparison of the actual performance and costs with the standards and working out the variances, i.e., the differences between the actuals and the standards.4. Analysis of the variances in order to determine the reasons for deviations of actuals from the standards.5. Presentation of information to the appropriate level of management to enable suitable action (remedial measures or revision of the standards) being taken.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 116Difference between Standard Costing and Budgetary Control:Like Budgetary Control, Standard Costing assume that costs are controllable alongdefinite lines of supervision and responsibility and it aims at managerial control bycomparison of actual performances with suitable predetermined yardsticks. The basicprinciples of cost control, viz., setting up of targets or standards, measurement ofperformance, comparison of actual with the targets and analysis and reporting ofvariances are common to both standard costing and budgetary control systems. Bothtechniques are of importance in their respective fields are complementary to each other.Thus, conceptually there is not much of a difference between standard costs andbudgeted and the terms budgeted performance and standard performance mean, formany concerns one and the same thing.

Budgets are usually based on past costs adjusted for anticipated future changes butstandard costs are of help in the preparation of production costs budgets. In fact,standards are often indispensable in the establishment of budgets. On the other hand,while setting standard overhead rates of standard costing purposes, the budgets framedfor the overhead costs may be made use of with modifications, if necessary. Thus,standard costs and budgets are interrelated but not inter-dependent.

Despite the similarity in the basic principles of Standard Costing and Budgetary Control,the two systems vary in scope and in the matter of detailed techniques. The differencemay be summarized as follows:1. A system of Budgetary Control may be operated even if no Standard Costing system is in use in the concern.2. While standard is an unit concept, budget is a total concept.3. Budgets are the ceilings or limits of expenses above which the actual expenditure should not normally rise; if it does, the planned profits will be reduced. Standards are minimum targets to be attained by actual performance at specified efficiency.4. 4. Budgets are complete in as much as they are framed for all the activities and functions of a concern such as production, purchase, selling and distribution, research and development, capital utilisation, etc. Standard Costing relates mainly to the function of production and the related manufacturing costs.5. A more searching analysis of the variances from standards is necessary than in the case of variations from the budget.6. Budgets are indices, adherence to which keeps a business out of difficulties. Standards are pointers to further possible improvements.

Advantages of Standard Costing:

The advantages derived from a system of standard costing are tabulated below:1. Standard Costing system establishes yard-sticks against which the efficiency of actual performances is measured.2. The standards provide incentive and motivation to work with greater effort and vigilance for achieving the standard. This increase efficiency and productivity all round.3. At the very stage of setting the standards, simplification and standardisation of products, methods, and operations are effected and waste of time and materials is eliminated. This assists in managerial planning for efficient operation and benefits all the divisions of the concern.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

1174. Costing procedure is simplified. There is a reduction in paper work in accounting and less number of forms and records are required.5. Cost are available with promptitude for various purposes like fixation of selling prices, pricing of interdepartmental transfers, ascertaining the value of costing stocks of work-in-progress and finished stock and determining idle capacity.6. Standard Costing is an exercise in planning - it can be very easily fitted into and used for budgetary planning.7. Standard Costing system facilities delegation of authority and fixation of responsibility for each department or individual. This also tones up the general organisation of the concern.8. Variance analysis and reporting is based on the principles of management by exception. The top management may not be interested in details of actual performance but only in the variances form the standards, so that corrective measures may be taken in time.9. When constantly reviewed, the standards provide means for achieving cost reduction.10. Standard costs assist in performance analysis by providing ready means for preparation of information.11. Production and pricing policies may be formulated in advance before production starts. This helps in prompt decision-making.12. Standard costing facilitates the integration of accounts so that reconciliation between cost accounts and financial accounts may be eliminated.13. Standard Costing optimizes the use of plant capacities, current assets and working capital.

Limitations of standard costing:

1. Establishment of standard costs is difficult in practice.2. In course of time, sometimes even in a short period the standards become rigid.3. Inaccurate, unreliable and out of date standards do more harm than benefit.4. Sometimes, standards create adverse psychological effects. If the standard is set at high level, its non achievement would result in frustration and build-up of resistance.5. Due to the play of random factors, variances cannot sometimes be properly explained, and it is difficult to distinguish between controllable and non-controllable expenses.6. Standard costing may not sometimes be suitable for some small concerns. Where production cannot be carefully scheduled, frequent changes in production conditions result in variances. Detailed analysis of all of which would be meaningless, superfluous and costly.7. Standard costing may not, sometimes, be suitable and costly in the case of industries dealing with non-standardized products and for repair jobs which keep on changing in accordance with customer‘s specifications.8. Lack of interest in standard costing on the part of the management makes the system practically ineffective. This limitation, of course, applies equally in the case of any other system which the management does not accept wholeheartedly.

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MANAGEMENT 118 4.2 COMPUTATION OF VARIANCES FOR EACH OF THE ELEMENTS OF COSTS, SALES VARIANCES

Variance AnalysisVariance Analysis is nothing but the differences between Standard Cost and Actual Cost.of course, in ordinary language we call it difference; in statistics we call it deviations andin costing terminology we call it as variances. When Standard Costing is adopted, thestandards are set for all the costs, revenue and profit, and if the difference in case of costis more than the standard we call it adverse variance, symbolized (A) and if thedifference is less than the standard, we call it favourable variance, symbolized (F).However, in case of sales and profit, if the standard is more than the actual it is adversevariance and if the standard is less than the actual it is favourable variance. From this weunderstand that variances can be calculated in all the elements of costs, sales and profittoo.

Causes of Material Price Variance:

a. Change in basic purchase price of material. b. Change in quantity of purchase or uneconomical size of purchase order. c. Rush order to meet shortage of supply, or purchase in less or more favourable market. d. Failure to take advantage of off-season price, or failure to purchase when price is cheaper. e. Failure to obtain (or availability of) cash and trade discounts or change in the discount rates. f. Weak purchase organisation. g. Payment of excess or less freight. h. Transit losses and discrepancies, if purchase price is inflated to include the loss. i. Change in quality or specification of material purchased. j. Use of substitute material having a higher or lower unit price. k. Change in materials purchase, upkeep, and store-keeping cost. (This is applicable only when such changes are allocated to direct material costs on a predetermined or standard cost basis.) l. Change in the pattern or amounts of taxes and duties.

Causes of Materials Usage Variance:

a. Variation in usage of materials due to inefficient or careless use, or economic use of materials. b. Change in specification or design of product. c. Inefficient and inadequate inspection of raw materials. d. Purchase of inferior materials or change in quality of materials e. Rigid technical specifications and strict inspection leading to more rejections which require more materials for rectification. f. Inefficiency in production resulting in wastages

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MANAGEMENT 121g. Use of substitute materials.h. Theft or pilferage of materials.i. Inefficient labour force leading to excessive utilisation of materials.j. Defective machines, tools, and equipments, and bad or improper maintenance leading to breakdowns and more usage of materials.k. Yield from materials in excess of or less than that provided as the standard yield.l. Faulty materials processing. Timber, for example, if not properly seasoned may be wasted while being used in subsequent processes.m. Accounting errors, e.g. when materials returned from shop or transferred from one job to another are not properly accounted for.n. Inaccurate standardso. Change in composition of a mixture of materials for a specified output.

(i) Direct Materials Mix Variance: one of the reasons for materials usage variance is the change in the composition of the materials mix. The difference between the actual quantity of material used and the standard proportion, priced at standard price.

Mix variance = (Revised Standard Quantity minus Actual Quantity) x Standard Price. = RSQSP-AQSP(ii) Direct Materials Yield Variance: yield variance is the difference between the standard cost of production achieved and the actual total quantity of materials used, multiplied by the standard weighted average price per unit. Material yield variance = (Standard yield for Actual Mix minus Actual yield) x Standard yield Price (Standard yield price is obtained by dividing the total cost of the standard units by the total cost of the standard mixture by the total quantity (number of physical units).

Causes of Direct Labour Rate Variances:

a. Change in basic wage structure or change in piece-work rate. These will give rise to a variance till such time the standards are not revised. b. Employment of workers of grades and rates of pay different from those specified, due to shortage of labour of the proper category, or through mistake, or due to retention of surplus labour. c. Payment of guaranteed wages to workers who are unable to earn their normal wages if such guaranteed wages form part of direct labour cost. d. Use of a different method of payment, e.g. payment at day-rates while standards are based on piece-work method of remuneration. e. Higher or lower rates paid to casual and temporary workers employed to meet seasonal demands, or urgent or special work. f. New workers not being allowed full normal wage rates. g. Overtime and night shift work in excess of or less than the standard, or where no provision has been made in the standard. This will be applicable only if overtime and shift differential payments form part of the direct labour cost. h. The composition of a gang as regards the skill and rates of wages being different from that laid down in the standard.

2. Direct Labour Efficiency Variance (also termed Labour Time Variance): The difference between the standard hours which should have been worked and the hours actually worked, valued at the standard wage rate. Direct Labour efficiency Variance = (Standard Hours for Actual Production minus Actual

= (SH-AH) x SR = SRSH-SRAH

Causes for Labour Efficiency Variance:

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MANAGEMENT 123 c. Delays due to waiting for materials, tools, instructions, etc. if not treated as idle time. d. Defective machines, tools and other equipments. e. Machine break-down, if not booked to idle time. f. Work on new machines requiring less time than provided for, till such time standard is not revised. g. Basic inefficiency of workers due to low morale, insufficient training, faulty instructions, incorrect scheduling of jobs, etc. h. Use of non-standard material requiring more or less operation time. i. Carrying out operations not provided for a booking them as direct wages. j. Incorrect standards k. Wrong selection of workers, i.e., not employing the right type of man for doing a job. l. Increase in labour turnover. m. Incorrect recording of performances, i.e., time or output.

(i) Direct Labour Composition or Mix or Gang Variance: This is a sub-variance

of labour efficiency variance. This variance arises due to change in the composition of a standard gang, or, combination of labour force

(ii) Direct Labour Yield Variance: Just as material yield variance is calculated, similarly labour yield variance can also be known. It is the variation in labour cost on account of increase or decrease in yield or output as composed to the relative standard. The formula is –

3. Idle time variance: This variance which forms a portion of wages efficiency variance, is represented by the standard cost of the actual hours for which the workers remain idle due to abnormal circumstances.

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124 SR = Standard Rate of Labour Per Hour SH = Standard Hours for Actual Production or output RSH = Revised Standard Hours AH = Actual Hours AR = Actual Rate of Labour per Hour 1. SRSH = Standard Cost of Standard Labour 2. SRRSH = Revised Standard Cost of Labour 3. SRAH = Standard Cost of Actual Labour 4. ARAH = Actual Cost of Labour = 1- a. Labour Sub-efficiency or yield Variance 2 = 2- b. Labour Mix or gang or Composition Variance 3 = 1- c. Labour efficiency Variance 3 = 3- d. Labour Rate Variance 4 = 1- e. Labour Cost Variance 4 Idle Time Variance = Idle Time Hours x Standard Rate per Hour. It is to be noted that this is the part and parcel of efficiency ratio and always it is adverse.III. Overhead Cost Variance: overhead cost variance or overall (or net) overhead variance is the difference between the actual overhead incurred and the overhead charged or applied into the job or process at the standard overhead rate. 1. Fixed Overhead Variance: Fixed overhead cost variance is the difference between the standard cost of fixed overhead allowed for the actual output achieved and the actual fixed overhead cost incurred. The fixed overhead variance is analysed as below: (i) Budget (or) Expenditure (or) Spending Variance: Fixed overhead variance which arises due to the difference between the budgeted fixed overheads and the actual fixed overheads incurred during a particular period. It shows the efficiency in spending. Expenditure variance arises due to the following:  Rise in general price level.  Changes in production methods.  Ineffective control. Fixed overhead expenditure or Budget Variance = Budgeted Fixed overhead - Actual Fixed overhead (ii) Volume Variance: Fixed overhead volume variance is the difference between standard cost of fixed overhead allowed for actual output and the budgeted fixed overheads for the period. This variance shows the over (or) under absorption of fixed overheads during a particular period. If the actual output is more than the budgeted output then there will be over recovery of fixed overheads and volume variance will be favourable and vice-versa. This is so because fixed overheads are not expected to change with the change in output. Volume variance arises due to the following reasons:  Poor efficiency of workers.  Poor efficiency of machinery.  Lack of orders.  Shortage of power.  Ineffective supervision.  More or less working days. COST & MANAGEMENT ACCOUNTING AND FINANCIAL 125MANAGEMENTVolume variance (Fixed Overhead) =Recovered Fixed overhead - Budgeted FixedoverheadVolume variance can be further sub divided into three variances namely:

a. Capacity Variance:It is that portion of the volume variance which is due to working at higher or lowercapacity than the standard capacity. In other words, the variance is related to the underand over utilization of plant and equipment and arises due to idle time, strikes and lock-out, break down of the machinery, power failure, shortage of materials and labour,absenteeism, overtime, changes in number of shifts. In short, this variance arises due tomore or less working hours than the budgeted working hours.

Calendar Variance:It is that portion of the volume variance which is due to the difference between thenumber of working days in the budget period and the number of actual working days inthe period to which the budget is applicable. If the actual working days are more than thebudgeted working days the variance will be favourable and vice-versa if the actualworking days are less than the budgeted days.

Calendar Variance = Standard Rate Per Hour or Per Day × excess or Deficit Hours or Days Worked

c. Efficiency Variance:It is that portion of the volume variance which is due to the difference between thebudgeted efficiency of production and the actual efficiency achieved.

2. Variable overhead variance:

This is the difference between the standard variable overhead cost allowed for the actual output achieved and the actual variable overhead cost. The variance is represented by expenditure variance only because variable overhead cost will vary in proportion to output so that only a change in expenditure can cause such variance.

Sometimes, variable overhead efficiency variance can also be calculated just like labour efficiency variance. Variable overhead efficiency can be calculated if information relating to actual time taken and time allowed is given. In that event variable overhead variance can be divided into two parts. (i) Variable overhead efficiency variance. (ii) Variable overhead expenditure (or) budget (or) price variance. Idle Time Variance = Idle Time Hours x Fixed overhead Rate per Hour

(i) Efficiency Variance: This variance is due to the difference between standard hours for actual output and the actual hours taken at the standard variable overhead rate. In other words, Variable overhead efficiency Variance is a measure of the extra overhead (or saving) incurred solely because direct labour usage exceeded (or was less than) the standard direct labour hours allowed.

(ii) Expenditure or Budget or Price Variance: This variance is due to the difference between standard variable overhead rate and actual variable overhead rate for the actual time taken. It is calculated on the pattern of Direct Labour rate Variance.

(iii) Sales Variance: The analysis of variances will be complete only when the difference between the actual profit and standard profit is fully analysed. It is necessary to make an analysis of sales variances to have a complete analysis of profit variance, because profit is the difference between sales and cost. Thus, in addition to the analysis of cost variances i.e., material cost variance, labour cost variance and overhead variance, an analysis of sales variance should be made. Sales variances analysis may be categorized into two: 1. Sales Value (or) Revenue variance. 2. Sales Margin (or) Profit variance.

Sales Value Variance is the difference between the budgeted value of sales and the actual value of sales during a period. Sales Value Variance may arise due to the following reasons:  Actual selling price may be higher or lower than the standard price.  Actual quantity of goods sold may be more or less than the standard.  Actual mix of the sales may be different than the standard mix.

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MANAGEMENT 128Sales Margin Variance is the difference between the budgeted profit and actual profit andthis is also the sum total of all variances. Sales Margin Variance may arise due to thefollowing reasons: Raise in general price level. unexpected competition. Ineffective sales promotion.

1. Sales Value Variance: The difference between budgeted sales and actual sales results in Sales Value Variance. If the actual sales are more than the budgeted sales, a favourable variance would be shown and vice versa. The formula is:

Sales Value variance = Budgeted Sales - Actual Sales

(i) Price Variance: This can be calculated just like Material Price Variance. It is an account of the difference in actual selling price and the standard selling price for actual quantity of sales. The formula for this is:

(ii) Volume Variance: It can be computed as Material usage Variance. Budgeted

sales may be different from the standard sales. In other words, budgeted quantity of sales at standard prices may vary from the actual quantity of sales at standard prices. Thus, the variance is as a result of difference in budgeted and actual quantities of goods sold. The formula is:

Volume Variance = Standard Price × (Budgeted Quantity - Actual

Quantity) Or = Budgeted Sales - Standard Sales

(b) Mix variance: When more than one product is manufactured and sold, the budgeted sales of different products are in a given ratio. If the actual quantities sold are not in the same proportion as budgeted, it would cause a mix variance.

It can be calculated according to two methods:

• Based on Quantity: This method is followed on those cases where products are homogenous. In case the formula for calculating Sales Mix Variance is on the same pattern as is used in case of Material Mix Variance.

Mix Variance = Standard Price × (Revised Standard Quantity - Actual

Quantity) = Revised Standard Sales - Standard Sales

If actual quantity is more than the revised standard quantity, it will result in favourablevariance or vice versa.

Revised Standard Quantity Total Quantity of Actual Mix × Standard

= Total Quantity of Standard Quantity Mix

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

129 Based on Value: This method is followed in those cases where products are not homogeneous. In such a case, the actual sales at standard prices, i.e. standard sales are to be expressed in budgeted ratios so as to calculate ‗revised standard sales‘ and then is compared with the actual sales at standard prices. The formula is:

(ii) Volume Variance: The profit at the standard rate on the difference between the standard and the actual volume of sales would be the amount of volume variance. The formula is:

Volume Variance = Budgeted Profit – Standard profit

or = Standard Rate of Profit × (Budgeted Quantity - Actual Quantity)

The Volume Variance can be divided into:

(a) Mix Variance: When more than one product is manufactured is manufactured and sold, the difference in profit can result because of the variation of actual mix and budgeted mix of sales. The difference between revised standard profit and the standard profit, therefore is the mix variance. The formula is:

Mix Variance = Revised Standard Profit – Standard Profit

(b)Quantity Variance: It results from the variation in profit because of difference in actual quantities sold and the budgeted quantities both taken in the same ratio. The actual quantities are to be revised in the ratio of standard mixture. The formula is: Quantity Variance = Budgeted Profit – Revised Standard Profit

4.3 INVESTIGATION OF VARIANCES – & REPORTING OF VARIANCES

Reporting of Variances:In order that variance reporting should be effective, it is essential that the followingrequisites are fulfilled:1. The variances arising out of each factor should be correctly segregated. If part of a variance due to one factor is wrongly attributed to or merged with that of another, the analysis report submitted to the management would be misleading and wrong conclusions may be drawn from it.2. Variances, particularly the controllable variances should be reported with promptness as soon as they occur. Mere operation of Standard Costing and reporting of variances is of no avail. The success of a Standard Costing system depends on the extent of responsibility which the management assumes in correcting the conditions which cause variances from standard. In order to assist the management in assuming this responsibility, the variances should be reported frequently and on time. This would enable corrective action being taken for future production while work is in progress and before the project or job is completed.3. For effective control, the line of organisation should be properly defined and the authority and responsibility of each individual should be laid down in clear terms. This will avoid ‗passing on the buck‘ and shirking of responsibility and will enable the tracing of the causes of variances to the appropriate levels of management.4. In certain cases, a particular variance may be the joint responsibility of more than one individual or department. It is obvious that if corrective action has to be effective in such cases, it should be taken jointly.5. Analysis of uncontrollable variances should be made with the same care as for controllable variances. Though a particular variance may not be controllable at the lower level of management, a detailed analysis of the off-standard situation may reveal far reaching effects on the economy of the concern. This should compel the top management to take corrective action, say, by changing the policy which gave rise to the uncontrollable variance.

Forms of Variance Reports:

The forms of reports for the different types of variances should be designed keeping inview the needs of the management and the size of the concern, and no standard formsare, therefore, suggested. Variance Analysis Reports prepared for the top managementwould obviously be more formal and would contain broad details only, while those meantfor presentation to the lower levels would contain details showing the causes of eachvariance and the specific responsibilities of the individuals concerned.

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MANAGEMENT 132 Variance Ratios and Cost Ratios: We have so far considered the various cost variances in absolute monetary terms. Although these show the extent of the variances, the information is insufficient if the management wants to study the trend of variances from period to period. Absolute figures in themselves do not give the full picture and it is only by comparison of one item with another that their correct relationship is obtained. Variance Ratios serve this need and comparison of these ratios from one period to another can be gainfully made. Another advantage of Variance Ratio is in regard to its applicability in the dual plan of standard cost accounting. With the help of the Cost Variance Ratios, standard costs of production and the standard values of inventory can be easily converted into actual costs for the purpose of incorporation in the financial accounts.

A number of ratios are used for reporting to the management the effective use of capacity, material, labour and other resources of a concern. Some of these are considered below: 1. Efficiency Ratio. 2. Activity Ratio. 3. Calendar Ratio. 4. Capacity usage Ratio 5. Capacity utilization Ratio. 6. Idle Time Ratio.

1. Efficiency Ratio: It is the standard hours equivalent to the work produced, expressed as a percentage of the actual hours spent in producing that work. Standard Hours Efficiency Ratio = × 100 Actual Hours

2. Activity Ratio: It is the number of standard hours equivalent to the work produced, expressed as a percentage of the budgeted standard hours. Activity Ratio = Standard Hours for Actual Work × 100 Budgeted Standard Hours

3. Calendar Ratio: It is the relationship between the number of working days in a period and the number of working days in the relative budget period. Calendar Ratio = Available Working Days × 100 Budgeted Working Days

4. Capacity Usage Ratio: It is the relationship between the budgeted number of working hours and the maximum possible number of working hours in a budget period. Budgeted Hours Maximum Possible Hours in Budget × Capacity usage Ratio = Period 100

5. Capacity Utilisation Ratio: It is the relationship between actual hours in a budget

period and the budgeted working hours in the period. Actual Hours Capacity utilisation Ratio Budgeted × = Hours 100

6. Idle Time ratio: It is the ratio of idle time hours to the total hours budgeted. Ideal Time Hours Idle Time Ratio = × 100 Budgeted Hours

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MANAGEMENT 133 4.4 VALUATION OF STOCK UNDER STANDARD COSTING

Stock Valuation:The function of a Balance Sheet is to give a true and fair view of the state of affairs of acompany on a particular date. A true and fair view also implies the consistent applicationof generally accepted principles. Stocks valued at standard costs are required to beadjusted at actual costs in the following circumstances:a. As per Indian Accounting Standards - 2, closing stock to be valued either at cost price or at net realisable value (NRV) whichever is less.b. The standard costing system introduced is still in an experimental stage and the variances merely represent deviations from poorly set standards.c. Occurrence of certain variances which are beyond the control of the management. (unless the stocks are adjusted for uncontrollable factors, the values are not correctly started).

Maintenance of Raw Material Stock at Standard Cost:

In the single plan, the inventory in the stores ledger may be carried either at standardcosts or at actual. Although both the methods are in use, the consensus is in favour ofstandard costs. The advantages of adopting standard costs for inventory valuation are asfollows:a. Stores ledger may be maintained in quantities only and the standard price noted at the top in the ledger sheets. This economises the use of forms as well as reduces clerical costs as no columns for rates need be maintained.b. Pricing of materials requisitions is simplified as only one standard price for each item of material is required to be used.c. Price variance is promptly revealed at the time of purchase of material.

The disadvantages are:

a. The stores ledger does not reveal the current prices.b. If the material stock is shown in the Balance Sheet at standard costs, the variances have the effect of distorting the profit or loss. Standard cost of the closing inventory is required to be adjusted to actual cost based on price variance to comply with the statutory requirement of the Companies Act, 2013.c. A revision of the standard necessitates revision of the cost of the inventory.

4.5 UNIFORM COSTING AND INTER-FIRM COMPARISON

Introduction:Uniform Costing is not a separate method or type of Costing. It is a technique of Costingand can be applied to any industry. Uniform Costing may be defined as the applicationand use of the same costing principles and procedures by different organisations underthe same management or on a common understanding between members of anassociation. The main feature of uniform costing is that whatever be the method ofcosting used, it is applied uniformly in a number of concerns in the same industry, oreven in different but similar industries. This enables cost and accounting data of themember undertakings to be compiled on a comparable basis so that useful and crucialdecisions can be taken. The principles and methods adopted for the accumulation,analysis, apportionment and

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MANAGEMENT 134allocation of costs vary so widely from concern to concern that comparison of costs isrendered difficult and unrealistic. Uniform Costing attempts to establish uniform methodsso that comparison of performances in the various undertakings can be made to thecommon advantage of all the constituent units.

Scope of Uniform Costing:

Uniform Costing methods may be advantageously applied:a. In a single enterprise having a number of branches or units, each of which may be a separate manufacturing unit.b. In a number of concerns in the same industry bound together through a trade association or otherwise, andc. In industries which are similar in nature such as gas and electricity, various types of transport, and cotton, jute and woollen textiles.

The need for application of uniform Costing System exists in a business, irrespective ofthe circumstances and conditions prevailing therein. In concerns which are members of atrade association, the procedure for uniform Costing may be devised and controlled bythe association or by any other central body specially formed for the purpose.

Requisites for Installation of a Uniform Costing System:

The organisational set up for implementing the principles and methods of uniformCosting may take different forms. It may range from a small association of a number ofconcerns who agree to have uniform information regarding a few specific cost accountingrespects, to be a large organisation which has a fully developed scheme covering all theaspects of costing. The success of a uniform costing system will depend upon thefollowing:a. There should be a spirit of mutual trust, co-operation and a policy of give and take amongst the participating members.b. There should be a free exchange of ideas and methods.c. The bigger units should be prepared to share with the smaller ones, improvements, achievements of efficiency, benefits of research and know-how.d. There should not be any hiding or withholding of information.e. There should be no rivalry or sense of jealousy amongst the members.

In the application of uniform Costing, the fundamental requirement is, therefore, to

locate such differences and to eliminate or overcome, as far as practicable, the causesgiving rise to such differences. The basic reasons for the differences may be as follows:

a. Size and organisational set up of the business:

The number and size of the departments, sections and services also vary from one concern to another according to their size and organisation. The difficulty in operating uniform Cost Systems for concerns which vary widely in regard to size and type of business may to some extent be overcome by arranging the various units in a number of size or type ranges, and applying different uniform systems for each such type.b. Methods of production: The use of different types of machines, plant and equipments, degree of mechanization, difference in materials mix and sequence and nature of operations and processes are mainly responsible for the difference in costs.

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MANAGEMENT 135c. Methods and principles of cost accounting applied: It is in this sphere that the largest degree of difference arises. undertakings manufacturing identical or similar products and having the same system of cost accounting would generally employ different methods of treatment of expenditure on buying, storage and issue of materials, pricing of stores issues, payment to workers, basis of classification and absorption of overhead, calculation of depreciation, charging rent on freehold or leasehold assets etc.

Fields covered by Uniform Costing:

There is no system of uniform Costing which may be found to ft in all circumstances. Thesystem to be installed should be tailored to meet the needs of each individual case. Theessential points on which uniformity is normally required may be summarized as follows:a. Whether costs are required for the individual products i.e. for the cost units or for cost centres.b. The method of costing to be applied.c. The technique employed such as Standard Costing, Marginal Costing.d. Items to be excluded from costs.e. The basis of departmentalization.f. The basis of allocation of costs to departments and/or service department costs to production departments.g. The methods of application administration, selling and distribution overhead to cost of sales.h. The method of valuation of work-in-progress.i. Methods of treating cost of spoilage, defective work, scrap and wastage.j. Methods of accounting of overtime pay bonus and other miscellaneous allowances paid to workers.k. Whether purchase, material handling and upkeep expenses are added to the cost of stores or are treated as overhead expenses.l. The system of materials control-pricing of issues and valuation of stock.m. The system of classification and coding of accounts.n. The method of recording accounting information.

Advantages of Uniform Costing:

Main advantages of a uniform Costing System are summarised below:(i) It provides comparative information to the members of the organisation/association which may by them to reduce or eliminate the evil effects of competition and unnecessary expenses arising from competition.(ii) It enables the industry to submit the statutory bodies reliable and accurate data which might be required to regulate pricing policy or for other purposes.(iii) It enables the member concerns to compare their own cost data with that of the others detect the weakness and to take corrective steps for improvement in efficiency.(iv) The benefits of research and development can be passed on the smaller members of the association lead to economy of the industry as a whole.(v) It provides all valuable features of sound cost accounting such as valued and efficiency of the workers, machines, methods, etc., current reports of comparing major cost items with the predetermined standards, etc.(vi) It serves as a prerequisite to Cost Audit and inter firm comparison.

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MANAGEMENT 136(vii) Uniform Costing is a useful tool for management control. Performance of individual units can be measured against norms set for the industry as a whole.(viii) It avoids cut-throat completion by ensuring that competition among member units proceeds on healthy lines.(ix) The process of pricing policy becomes easier when uniform Costing is adopted.(x) By showing the one best way of doing things, uniform Costing creates cost consciousness and provides the best system of cost control and cost presentation in the entire industry.(xi) Uniform costing simplifies the work of wage boards set up to fix minimum wages and fair wages for an industry.

Limitations of Uniform Costing:

(i) Uniform costing presumes the application of same principles and methods of Costing in each of the member firms. But individual units generally differ in respect of certain key factors and methods.(ii) For smaller units the cost of installation and operation of uniform Costing System may be more than the benefits derived by them.(iii) Uniform costing may create conditions that are likely to develop monopolistic tendencies within the industry. Prices may be raised artificially and supplies curtailed.(iv) If complete agreement between the members is not forthcoming, the statistics presented cannot be relied upon. This weakens the uniform Costing System and reduces its usefulness.

Inter Firm Comparison

Inter-firm comparison as the name denotes means the techniques of evaluating theperformances, efficiencies, deficiencies, costs and profits of similar nature of firmsengaged in the same industry or business. It consists of exchange of information,voluntarily of course, concerning production, sales cost with various types of break-up,prices, profits, etc., among the firms who are interested of willing to make the device asuccess. The basic purposes of such comparison are to find out the work points in anorganisation and to improve the efficiency by taking appropriate measures to wipe outthe weakness gradually over a period of time.

The benefits which are derived from Inter-firm Comparison are appended below:a. Inter-firm Comparison makes the management of the organisation aware of strengths and weakness in relation to other organisations in same industry.b. As only the significant items are reported to the Management time and efforts are not unnecessary wasted.c. The management is able to keep up to data information of the trends and ratios and it becomes easier for them to take the necessary steps for improvement.d. It develops cost consciousness among the members of the industry.e. Information about the organisation is made available freely without the fear of disclosure of confidential data to outside market or public.f. Specialized knowledge and experience of professionally run and successful organisations are made available to smaller units who can take the advantages it may be possible for them to have such an infrastructure.

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MANAGEMENT 137g. The industry as a whole benefits from the process due to increased productivity, standardization of products, elimination of unfair comparison and the trade practices.h. Reliable and collective data enhance the organising power in deal in with various authorities and government bodies.i. Inter firm comparison assists in a big way in identifying industry sickness and gives a timely warning so that effective remedial steps can be taken to save the organisation.

Limitations of Inter-firm Comparison:

The practical difficulties that are likely to arise in the implementation of a scheme ofinter-firm comparison are:a. The top management may not be convinced of the utility of inter-firm comparison.b. Reluctance to disclose data which a concern considers to be confidential.c. A sense of complacence on the part of the management who may be satisfied with the present level of profits.d. Absence of a proper system of Cost Accounting so that the costing figures supplied may not be relied upon for comparison purposes.e. Non-availability of a suitable base for comparison.

These difficulties may be overcome to a large extent by taking the following steps:a. ‗Selling‘ the scheme through education and propaganda. Publication of articles in journals and periodicals, and lecturers, seminars and personal discussions may prove useful.b. Installation of a system which ensures complete secrecy.c. Introduction of a scientific cost system.

=[628 x 40%] + [430 x 25%] + [350 x 20%] + [230 x 15%]

Illustration 2:The standard costs of a certain chemical mixture is:40% Material A at `200 per ton60% Material B at `300 per tonA standard loss of 10% is expected inproduction During a period they used90 tons of Material A at the cost of `180 per ton110 tons of Material B at the cost of `340 per tonThe weight produced is 182 tons of good production.

Illustration 3:SV Ltd., manufactures BXE by mixing 3 raw materials. For every batch of 100 kg. of BXE,125 kg of raw materials are used. In April 2012, 60 batches were prepared to produce anoutput of 5600 kg of BXE. The standard and actual particulars for April, 2012 are asunder:

Illustration 4:A brass foundry making castings which are transferred to the machine shop of thecompany at standard price uses a standard costing system. Basing standards in regard tomaterial stocks which are kept at standard price are as follows

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 142Illustration 5:A company manufacturing a special type of fencing tile 12‖X 8‖ X 1\2‖ used a system ofstandard costing. The standard mix of the compound used for making the tiles is:1,200 kg. of Material A @ `0.30 per kg.500 kg. of Material B @ `0.60 per kg.800 kg. of Material C @ `0.70 per kg.

Illustration 13:A manufacturing co. operates a costing system and showed the following data in respectof the month of November.Actual no. of working days 22Actual man hours worked during the month 4,300No. of Products Produced 425Actual overhead incurred ` 1,800Relevant information from the company‘s budget and standard cost data is asfollows:Budgeted no. of working days per month 20Budgeted man hours per month 4,000Standard man hours per product 10Standard overhead rate per month per hour 50 p.you are required to calculate the overhead variances for the month of November

MULTIPLE CHOICE QUESTIONS:

1. Which of the following is true about standard costs?

A. They are the actual costs for delivering a product or service under normal conditions B. They are predetermined costs for delivering a product or service under normal conditions. C. They are the actual costs for producing a product under normal conditions D. They are predetermined costs for delivering a product or service under normal and abnormal conditions.2. Which of the following is true? A. Standard costs are predetermined rates for materials and labour only. B. Standard costs are predetermined rates for materials only. C. Standard costs are based on actual activity at the end of the period D. Standard costs are predetermined rates for materials, labour, and overhead.3. Which of the following is often the cause of differences between actual and standard costs of materials and labour? A. Price changes for materials B. Excessive labour hours C. Excessive use of materials D. All of the above4. Which of the following can be used to calculate the materials price variance? A. (AQ – SQ) x SP B. (AP – SP) x AQ C. (AP – SP) x SQ D. (AQ – SQ) x AP5. Which of the following is the difference between actual and standard cost of material caused by the actual quantity of material used exceeding the standard quantity of material allowed? A. Price variance B. Mix variance C. Quantity variance D. Yield variance6. Which of the following departments is most likely responsible for a price variance in direct materials? A. Warehousing B. Receiving C. Purchasing D. Production7. The overhead variance is caused by the difference between which of the following? A. Actual overhead and standard overhead applied B. Actual overhead and overhead budgeted at the actual operating level C. Standard overhead applied and budgeted overhead D. Budgeted overhead and overhead applied8. When are the overhead variances recorded in a standard costing system? A. When the cost of goods sold is recorded

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 162 B. When the factory overhead is applied to work-in-process C. When the goods are transferred out of work-in-process D. When direct labour is recorded9. Which of the following is true when recording variances in a standard costing system? A. All unfavourable variances are debited B. Only unfavourable material variances are credited. C. Only unfavourable material variances are debited. D. Only unfavourable variances are credited.10. Which of the following operating measures would a manager want to see decreasing over time? A. Merchandise inventory turnover B. Total quality cost C. Percentage of on-time deliveries D. Finished goods inventory turnover

State whether the following statement is True or False:

1. Standard costing works on the principle of exception.

2. An increase in production means an increase in overall productivity.3. Difference between the standard cost and actual cost is called as variance.4. Uniform costing helps in free exchange of ideas among the participating members.5. A variance may be either favourable or adverse.6. There is no difference between standard costing and budgeting.7. The objective of uniform costing is wealth maximisation.8. Uniform costing is a method of costing.9. Uniform costing is a must for meaningful in a firm comparison.10. Standards are arrived at on the basis of past performance.

COST & MANAGEMENT ACCOUNTING AND FINANCIAL

MANAGEMENT 163Fill in the Blanks:

1. Ideal time variance is always ________________.

2. Material usage variance is the sum of ______________.3. ____________ is a must for meaningful inter firm comparison.4. Standard cost is the ___________ cost.5. Uniform costing is a _____________ of costing.6. Inter firm comparison is the technique of evaluation of _____________.7. Standard cost is a _____________cost.8. Three types of standard ______________.9. Standards costing are applied in ____________ industry.10. When standard cost is less than the standard cost, it is known as ___________ variance.